The equation at the heart of prices, the ‘Quantity theory of money‘, centuries old but redeveloped by the likes of Irving Fisher, Ludwig Von Mises and Simon Newcombe, as well as being an equation restated by Milton Friedman which resulted in a Nobel prize. The equation, known as the “quantity theory of money” is MV = PT.
M is the quantity of money, V is the speed money flows round the economy, P is the level of prices and T is the number of transactions.
The formula has had one consistent feature, namely controversy. If you believe V and T are stable, then control of the money supply guarantees control of inflation. Quantitative easing (which they are talking about presently in the UK) raises M, so if V is fixed, it will push up P or T or both.
In today’s recessionary and deflationary world, that would be a welcome result. However, if banks, companies or households hoard money or sit on the extra cash it sends V down, M may go up while P and T still fall. Historically V has never been sufficiently predictable to be reliable for use in policy, you can only assume velocity, with the downside risk that velocity get pent up and then suddenly be released resulting in powerful inflation.
Today’s video is not from a famous economist, it’s from a regular guy who is talking about economics, I thought it might make for a change to post something from the ‘non-media’ realm.