The Quantity Theory and the Velocity of Money

The quantity theory of money explains the link between inflation and money growth. The
equation of exchange tells us that the quantity of money times the velocity of money equals
nominal GDP. Money growth plus velocity growth equals inflation plus real growth. If velocity
and real growth were constant, the central bank could control inflation by keeping money growth
constant. In the long run, velocity is stable, so controlling inflation means controlling money
In the short run, the velocity of money is volatile. Shifts in velocity are caused by changes in
the demand for money. The demand for money depends on income, interest rates, and the
availability of alternative means of payment. The portfolio demand for money depends on the
same factors that determine the demand for bonds: wealth, expected future interest rates, and
the return, risk, and liquidity associated with money relative to alternative investments.
The quantity theory of money and theories of money demand have a number of implications for
monetary policy. Countries with inflation can reduce inflation by controlling money growth.
Countries with inflation can control inflation by targeting money growth only if the demand for
money is stable in the short run.
In the United States, the relationship between the velocity of M2 and its opportunity cost (the
yield on an alternative investment) has proven unstable over time. The instability of money
demand in the United States has caused Federal Reserve policymakers to pay less attention to
money growth than to interest rates. In the euro area, ECB officials view money demand as
relatively stable, so they pay more attention to money growth than the Fed does.
Analysis macro state of the country with respect to the country ability to maintain stable price (P
) through monetary policy in future. (You should state in your analysis: what is the appropriate
target for the monetary policy: it is Money growth or interest rate? And also you should explain
Learning Objectives
To analyze the current state of the macro economy.
To become familiar with the sources and presentation of economic data.
To practice writing brief academic reports.
You should:
State the theoretical explanation of the case as you have learned in the class. (50 point)
Plot the chosen variables in one or multiple graphs. (50 point)
Prepare a 2-3 page typewritten evaluation report (based on what see from data and graphs).






















































































Sample Solution