Activity 36

Keeping in mind that Irving Fisher wrote his equation as MV=PT, AP will always refer to the equation as MV=PQ. Define in your own words each of the variables in the monetary equation of exchange. M: V: P: Q:

Keeping in mind that Irving Fisher wrote his equation as MV=PT, AP will always refer to the equation as MV=PQ. Define in your own words each of the variables in the monetary equation of exchange. M: V: P: Q:

2. The product of velocity (V) and the money supply (M) equals PQ. How can PQ be defined?

2. The product of velocity (V) and the money supply (M) equals PQ. How can PQ be defined?

3. Suppose velocity remains constant, while the money supply increases. Explain how this would affect nominal GDP.

3. Suppose velocity remains constant, while the money supply increases. Explain how this would affect nominal GDP.

4. During the previous thirty years, the use of credit cards increased, and banks and other financial institutions increasingly use computers for transactions. Explain how these changes might affect velocity.

4. During the previous thirty years, the use of credit cards increased, and banks and other financial institutions increasingly use computers for transactions. Explain how these changes might affect velocity. V would increase. A given stock of money could “work harder” and finance more transactions more quickly.

5. As a result of legislative and regulatory reform throughout the 1980s and 1990s, banks and other financial institutions began paying interest on a significant proportion of the checkable deposits in the M1 definition of the money supply. Explain how these changes might be expected to affect the velocity of M1.

5. As a result of legislative and regulatory reform throughout the 1980s and 1990s, banks and other financial institutions began paying interest on a significant proportion of the checkable deposits in the M1 definition of the money supply. Explain how these changes might be expected to affect the velocity of M1. V would decrease. People would be willing to hold, not spend M if it paid interest.

M1 Chart fig 36.1 YearM1 (billions of $) V (velocity) P Implicit Price Deflator for GDP Q Real GDP (billions of $) PQ Nominal GDP (billions of $) 1987$ $6,114$4, ,3705, ,5925, ,7075, ,6776, , ,8806, , ,0636, , , ,5447, , ,8137, , ,1608, , , , ,8769, , ,3209,768.90

M1 Chart fig 36.1 YearM1 (billions of $) V (velocity) P Implicit Price Deflator for GDP Q Real GDP (billions of $) PQ Nominal GDP (billions of $) 1987$ $6,114$4, ,3705, ,5925, ,7075, ,6776, , ,8806, , ,0636, , ,3487, , ,5447, , ,8137, , ,1608, , ,5108, , ,8769, , ,3209,768.90

M2 Chart fig 36.2 YearM1 (billions of $) V (velocity) P Implicit Price Deflator for GDP Q Real GDP (billions of $) PQ Nominal GDP (billions of $) 1987$2, $6,114$4, , ,3705, ,1586,5925, , ,7075, , ,6776, , ,8806, , ,0636, , ,3487, , , , , , , ,5108, , ,8769, , ,3199,963

M2 Chart fig 36.2 YearM1 (billions of $) V (velocity) P Implicit Price Deflator for GDP Q Real GDP (billions of $) PQ Nominal GDP (billions of $) 1987$2, $6,114$4, , ,3705, , ,5925, , ,7075, , ,6776, , ,8806, , ,0636, , ,3487, , ,5447, , , , ,1558, , ,5108, , ,8769, , ,3199,963

7. What might one correctly infer from the changes of the 1980s and 1990s about the classical assumption that institutional factors determine velocity

Velocity does not remain constant when institutional factors change. It has been increasing.

8. Use the M1 and M2 data to plot income velocity from 1987 to Velocity M1 M2

8. Using M1 and M2 data to plot income velocity from 1987 to Velocity M1 M2

8. Using M1 and M2 data to plot income velocity from 1987 to Velocity M1 M2 What is the difference in the value of M1 velocity and M2 velocity? Explain why they are different. What trends do you see?

8. Using M1 and M2 data to plot income velocity from 1987 to Velocity M1 M2 Velocity of M1 is much higher than velocity of M2. M1 is used for transactions, while a significant portion of M2 is used for saving – so it doesn’t change on a daily, weekly or monthly basis. Velocity of M1 has more volatility than M2. Both have risen over time.