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    velocity theory of money and price level

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    To control the price level in a Classical model (e.g., to have zero inflation in an economy where the quantity theory of money holds), the monetary system must necessarily do the following:

    a. Abandon fiat money, and go to a gold standard;
    b. Use fiat money, abandon the gold standard, and have a Central Bank that is active;
    c. Assuming velocity is stable (e.g., its growth rate is constant), it must try to keep the money supply growing relatively close to the growth rate of output;
    d. Assuming velocity is growing, it must try to keep money stock growing at the growth rate of output.

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    Solution Preview

    The velocity theory of money states that MV = PQ which can be rearranged to P= MV/Q. If V were ...

    Solution Summary

    This solution discusses how the velocity theory of money causes changes to the price level with changes to the money supply.