The identity
expresses the relationship between the money supply and national income or nominal
GDP.
It provides the rationale for using monetary aggregates to influence inflation,
either directly through intermediate targets as in the past, via the sort of pragmatic
analysis which took its place or the more dramatic policy of quantitative easing.
In this expression:
- M is the stock of money,
- V is the velocity of circulation (i.e.
the number of times that stock of money circulates in a given time period),
- T is the volume of transactions and
- P is a measure of the average price level.
T can be thought of as real national income and PT, therefore, as nominal national
income or nominal GDP.
Having chosen a suitable measure for the money stock, it is then possible to calculate
the velocity of circulation, the only part of the expression which is not directly
measurable.
