The Quantity Theory of Money – V (Part Two)
This is a visual addendum to my earlier post about inflation vs. deflation and the quantity theory of money. As a reminder, Friedman postulates that inflation is caused by an increase in the money supply; the quantity theory of money in its simple form states that the amount of money in an economy multiplied by its velocity equals the real value of goods in the economy times the price level, or M*V = P*Q. So an increase in the money supply, ceteris paribus, should result in an increase in price levels.
As I noted last month, the US monetary base has recently seen drastic increases. We haven’t seen rising inflation, though, because all the additional money that the Fed has been printing is getting soaked up by banks upping their reserves. FT Alphaville’s Stacey-Marie Ishmael posted an impressive chart yesterday showing this decrease in the velocity of money.
You can find the original here. And if you’re sifting through the FT Alphaville archives, also take a look at the hyperinflation scenario that Morgan Stanley sees as a (not highly likely, but realistic) possibility.