According to Irving Fisher, when velocity and output are fixed, the quantity theroy of money implies that inflation equals money growth. What does the quantity theory imply for inflation in the long run in an economy with growing output and stable velocity?

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Business

Bruno Escobar

30 October, 00:19

According to Irving Fisher, when velocity and output are fixed, the quantity theroy of money implies that inflation equals money growth. What does the quantity theory imply for inflation in the long run in an economy with growing output and stable velocity?

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Olsen · Answer 1

It implies that inflation depends on the growth of the money supply.

Explanation:

This idea is better known as the Quantity Theory of Money, which states that:

M*V = P*T

Where:

M = Money Supply

V = Velocity

P = Price level in the economy

T = Output in physical terms

Velocity is constant, and T is fixed by the factors of production, thus, only two variables vary: Money supply and price level.

This means that he higher the money supply, the higher the price level in an economy in the long-run, because as more money pours into the system, all prices expressed in monetary units rise because output has stayed the same. (there is the same amount of goods and services but now there is more money).

This is why hyperinflation has always been caused by an excessive growth of the money supply, mostly because of government printing.