Connecting Fisher’s Equation to the Quantity Theory of Money

Question 1

What is Fisher’s Equation of Exchange?

Answer 1

M * V = P * Q

Where M = Money supply, V = Velocity of money, P = Price level, Q = Real output (real GDP)

Question 2

What does the Quantity Theory of Money (QTM) build on?

Answer 2

Fisher’s Equation of Exchange

QTM expands upon the relationships outlined in Fisher’s Equation.

Question 3

What assumption does the Quantity Theory of Money make about velocity (V)?

Answer 3

Velocity (V) is stable

Money circulation habits change slowly.

Question 4

What determines real output (Q) according to the Quantity Theory of Money?

Answer 4

Real factors:
* Productivity
* Technology
* Labor

These factors influence the overall output of the economy.

Question 5

What happens to price level (P) if money supply (M) increases while real output (Q) is constant?

Answer 5

Leads to a proportional increase in P (inflation)

This reflects the relationship between money supply and inflation in the QTM.

Question 6

What is the key argument of Milton Friedman regarding inflation?

Answer 6

Inflation is always and everywhere a monetary phenomenon.

Question 7

What is the primary cause of inflation according to monetarists?

Answer 7

Excessive money supply growth.

Question 8

What factors are considered secondary in the cause of inflation?

Answer 8

Demand-side factors and wage-price spirals.

Question 9

What is the policy prescription for controlling inflation according to monetarists?

Answer 9

Control inflation via steady, predictable expansion of money supply aligned with real GDP growth.

Question 10

Which UK leader implemented monetarist policies in the 1980s?

Answer 10

Margaret Thatcher.

Question 11

What was Paul Volcker’s role regarding monetarist policies in the 1980s?

Answer 11

He targeted money supply to combat inflation as the US Federal Reserve Chair.

Question 12

What challenge did monetarist policies face in the 1980s?

Answer 12

Instability in money demand led to a shift from monetary targets to interest rate targeting.

Question 13

What event in Weimar Germany led to hyperinflation from 1921 to 1923?

Answer 13

Excessive money printing to pay WWI reparations

This period is characterized by extreme devaluation of the currency due to the government’s financial policies.

Question 14

When did hyperinflation peak in Weimar Germany, and what was the exchange rate at that time?

Answer 14

November 1923: 4.2 trillion Reichsmarks per US dollar

This extreme devaluation illustrates the consequences of excessive monetary expansion.

Question 15

What was the inflation rate in Zimbabwe in 2008?

Answer 15

89.7 sextillion percent per month

This staggering rate led to the currency becoming worthless and a reliance on foreign currencies.

Question 16

What actions did the Zimbabwean government take that contributed to hyperinflation?

Answer 16

Printed money to finance deficits

This strategy resulted in severe economic instability and loss of currency value.

Question 17

What factors contributed to hyperinflation in Venezuela during the 2010s?

Answer 17

Excessive money supply growth, collapse in productive output, lack of confidence in the domestic currency

These factors combined created a severe economic crisis leading to hyperinflation.

Question 18

What was the inflation rate in Venezuela in 2018?

Answer 18

Over 1,000,000%

This astronomical figure reflects the extreme economic turmoil faced by the country.

Question 19

Fill in the blank: Hyperinflation in Weimar Germany peaked in _______.

Answer 19

November 1923

Question 20

True or False: Zimbabwe’s government printed money to finance its budget deficits, leading to hyperinflation.

Answer 20

True

Question 21

Fill in the blank: Venezuela’s hyperinflation in the 2010s was characterized by a lack of _______ in the domestic currency.

Answer 21

confidence

Question 22

What does the Quantity Theory of Money suggest about excessive money supply growth?

Answer 22

It causes severe inflation.

This is confirmed by historical hyperinflations.

Question 23

What are the policy implications of the Quantity Theory of Money?

Answer 23

Framework for central bank monetary policy including:
* Inflation targeting
* Monetary base control

These strategies help manage inflation effectively.

Question 24

What is an example of a successful inflation-targeting regime?

Answer 24

Bank of England’s 2% inflation target in the 1990s-2000s.

This illustrates the monetarist legacy of successful inflation control.

Question 25

True or False: Historical hyperinflations provide empirical support for the Quantity Theory of Money.

Answer 25

True. ## Footnote They demonstrate the direct link between money supply and inflation.

Question 26

Fill in the blank: The Quantity Theory of Money is a framework for _______.

Answer 26

[central bank monetary policy]. ## Footnote This includes strategies like inflation targeting and controlling the monetary base.

Question 27

What do Keynesians argue about short-run instability in relation to increases in M?

Answer 27

In the short run, increases in M do not always translate directly into inflation, especially with excess capacity or liquidity traps. ## Footnote This was exemplified during the 2008 Global Financial Crisis with unprecedented monetary expansion without immediate inflation.

Question 28

What is the concept of velocity variability?

Answer 28

Velocity is not always stable and can change dramatically due to financial innovation, economic uncertainty, and policy shifts, undermining the predictive power of the Quantity Theory of Money (QTM). ## Footnote This contrasts with monetarist assumptions that velocity remains constant.

Question 29

What do Post-Keynesians argue about the money supply?

Answer 29

They argue that the money supply is endogenous, responding to the demand for credit rather than being directly controlled by central banks.

Question 30

What does Fisher’s Equation help to understand?

Answer 30

Inflation dynamics ## Footnote Fisher's Equation relates nominal interest rates, real interest rates, and inflation rates.

Question 31

Under what conditions does the Quantity Theory of Money (QTM) hold?

Answer 31

Extreme cases like hyperinflation ## Footnote QTM is less reliable in stable economies with financial complexity.

Question 32

How has monetarism influenced monetary policy?

Answer 32

It shaped monetary policy but now integrates with Keynesian insights ## Footnote This reflects a shift toward a more blended approach in economic theory.

Question 33

What tools do central banks use today to manage the economy?

Answer 33

Interest rates and inflation expectations ## Footnote This marks a departure from strict money supply controls.