page_title: Inflation
section_title: Monetarist view
hierarchical_section_title: Inflation / Causes / Monetarist view
caption_attribution_description: English: Chart of M2 money supply growth and inflation as measured by the GNP price deflator. Data from 1875 to 1959 are taken from Appendix B of The American Business Cycle: Continuity and Change (edited by Robert Gordon). Data available here: http://www.nber.org/data/abc/. Data from 1959 onward are taken from the Fred database. Series IDs GNPDEF and MSNS. See for similar charts: http://research.stlouisfed.org/publications/review/98/11/9811wd.pdf and https://www.clevelandfed.org/Research/Commentary/1999/0801.pdf
context_page_description: In economics, inflation is a general rise in price level relative to available goods resulting in a substantial and continuing drop in purchasing power in an economy over a period of time.
  When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation reflects a reduction in the purchasing power per unit of money – a loss of real value in the medium of exchange and unit of account within the economy. The opposite of inflation is deflation, a sustained decrease in the general price level of goods and services. The common measure of inflation is the inflation rate, the annualized percentage change in a general price index, usually the consumer price index, over time.
  Economists generally believe that very high rates of inflation and hyperinflation are caused by an excessive growth of the money supply. Views on which factors determine low to moderate rates of inflation are more varied. Low or moderate inflation may be attributed to fluctuations in real demand for goods and services, or changes in available supplies such as during scarcities.
context_section_description: Monetarists believe the most significant factor influencing inflation or deflation is how fast the money supply grows or shrinks. They consider fiscal policy, or government spending and taxation, as ineffective in controlling inflation. The monetarist economist Milton Friedman famously stated, "Inflation is always and everywhere a monetary phenomenon."
  Monetarists assert that the empirical study of monetary history shows that inflation has always been a monetary phenomenon. The quantity theory of money, simply stated, says that any change in the amount of money in a system will change the price level. This theory begins with the equation of exchange:
  where
   is the nominal quantity of money;
   is the velocity of money in final expenditures;
   is the general price level;
   is an index of the real value of final expenditures;
  In this formula, the general price level is related to the level of real economic activity (Q), the quantity of money (M) and the velocity of money (V). The formula is an identity because the velocity of money (V) is defined to be the ratio of final nominal expenditure () to the quantity of money (M).
  Monetarists assume that the velocity of money is unaffected by monetary policy (at least in the long run), and the real value of output is determined in the long run by the productive capacity of the economy. Under these assumptions, the primary driver of the change in the general price level is changes in the quantity of money. With exogenous velocity (that is, velocity being determined externally and not being influenced by monetary policy), the money supply determines the value of nominal output (which equals final expenditure) in the short run. In practice, velocity is not exogenous in the short run, and so the formula does not necessarily imply a stable short-run relationship between the money supply and nominal output. However, in the long run, changes in velocity are assumed to be determined by the evolution of the payments mechanism. If velocity is relatively unaffected by monetary policy, the long-run rate of increase in prices (the inflation rate) is equal to the long-run growth rate of the money supply plus the exogenous long-run rate of velocity growth minus the long run growth rate of real output.
caption: Inflation and the growth of money supply (M2)
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