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Unformatted text preview: The Monetary Rule and the Equation of Exchange The Equation of Exchance M V = P Y The amount of money times the number of times it is spent = Total Spending Output produced (Y) times the price of that output (P) = Total Spending P Y = Nominal GDP Velocity (V) = Nominal GDP M The Monetary Rule M V = Y ∆ ∆ The Equation of Exchange states that the amount of money times the number of times it is spent (MV) is equal to total spending. That amount is also equal to the output produced times the price of that output (PY). So, the equation says that total spending equals total spending. Brilliant. A statement that is true by definition is called a “Tautology” and the Equation of Exchange is a famous example. However, when we consider that a major goal of monetary policy is price stability, it becomes clear that the equation of exchange tells us what the money supply should be if we want to hold the price level constant. The equality between MV and PY is preserved if any percentage change applied to MV is also applied to...
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- Winter '11
- Inflation, monetarism, Milton Friedman, monetary rule