MV=PT A Classic Equation and Monetary Policy

MV=PT
Irving Fisher was one of the most popular economists of the early twentieth century.
Given that economists are not known as popular figures, we must take that with a
grain of salt.
In 1911 he came up with the Equation of Exchange concept. That equation was
MV=PT, where M was representative of the amount of money, V equaled velocity, P was
price and T represented transactions.
In its time a landmark theory, many people still consider the equation to be the single
most important mathematical description of economics.
Others downplay its significance or find it mildly useful. It helps their case that Irving
was quoted as proclaiming just before the crash of 1929, Stock prices have reached
what looks like a permanently high plateau. Needless to say his finances soon suffered
in a significant way. He was also the first president of the American Eugenics Society.
Since we are concerned with how this equation could be applied to monetary policy,
whether Fiat or fixed, we can solve for M or Money by dividing both sides by V or
velocity.
M= PT/V
Money equals price times transactions divided by velocity. Now, the most common
problem people have with Irvings formula is with V. If we omit V entirely, we come up
with an equation that is hard to argue with.
M=PT
The amount of money equals the number of transactions times the price. This would be
true by definition.

Fishers calculation of V was the total expenditures for a time period, usually a year,
divided by the average amount of money in circulation for the same time period.
Another practical definition for V or Velocity is the number of times that it takes the
Money Supply to circulate before the total output or PT, of the economy is purchased.
That would seem to be very difficult to account.
There is a debate over whether in our contolled economy, existing money can ever be
not used. The only possible way to not use money is to store it in a container and not
touch it. With any insight, one can immediately see that this is not what banks do with
your money, even though that is what they claim.
If Fishers equation is truly an equation, then V can be solved if the other factors are
known. If we know M or money and we know the amount of transactions and the price,
V can be determined, although this is no easy task. .
In our fiat economy, M can be altered and is altered, at any time by the actions of a
central bank. The policies and actions of the Federal Reserve and the Treasury, rather
than the market, determine the level of M. A central bank, by issuing Securities, can
introduce new money to a localized economy, if they receive a foreign buyer. A central
bank can also introduce new money to the world by purchasing existing securities with
new money.
P=MV/T
When the value for M is made greater, the hope is that the number of transactions will
increase or the Velocity will fall or a combination of the two will occur. As you can see by
the equation above where we solved for P or Price, there isnt a lot of room to wiggle. If
these results dont come to pass nor reach the extent needed to balance the change in
M, then P will increase.
Even if this policy is successful, the possibility of price inflation looms on the horizon.
The economy has been stimulated by new capital, an influence outside the usual realm
of supply and demand of labor, resource or existing capital. Unless there was previously

a significant overproduction with a corresponding slowdown in the demand for labor,

price inflation will result.
Monetary inflation always results when new money is introduced, simply by definition.
Often, the reason given for the dismissal of a fixed currency is the limits or
constrictions it places on an economy. We have seen what a variable M does to Irvings
equation, does a fixed value M place restrictions on output?
If we set M as a constant amount, any increase in T must coincide with a decrease in P
or an increase in V to maintain the equation: prices must fall or the velocity must
increase or both, when more transactions occur in an economy with a fixed currency. As
the economy grows, prices can actually experience downward pressure, money is
constant but gains value because there are more goods and services or commodities
represented by the same amount of currency. In other words, the value of M can
increase when the amount of M remains constant.
This isnt to say that prices cant inflate and/or transactions cant fall or velocity wont
slow with a fixed currency. What it is saying is that what happens in the economy
directly affects the value of money without any change in the amount. That is, how we
use our labor to craft resources to meet the needs of our daily lives determines the
value of the medium of exchange [money]. When the economy grows in a healthy way,
we all share in the profit as our currency becomes stronger and is able to purchase
more.
The Fiat system in the best light would be hard pressed to offer us this combination.
By entering a greater amount of M into the system now, we are attempting to jump
ahead to a point in the future of the economy where greater output has already been
reached. This is basically an attempt to experience the benefits without doing the work
required.
Because this method of monetary control is a directed method, the benefits and the
resulting drawbacks can and are directed by whoever is controlling the release of

monies to wherever in the economy they deem worthy of the good effects or whoever
they deem deserving of the bad effects.
In relation to the M=PT/V equation perhaps the biggest difference between a Fiat
monetary system and one based on a fixed value is which side of the equation we deem
the most vital. The Fiat policy stresses the importance of the left side of the equation,
using different, almost always increasing amounts of M to attempt to determine the
outcome of the right side. With a fixed or free economy {and they arent one and the
same}, the results that the economy provides us on the right side of the equation
determine the value of the left.
Most importantly, the fiat system of money production is a vital part of the controlled
economy. Regardless of what outcome we are promised or what an equation may
attempt to justify, there is no doubt that an economy that is controlled is not a free
economy. That is ultimately the most important factor to consider.