Quantity Theory of Money
The theory that price levels rise proportionally with the money supply, expressed as MV = PQ.
What is Quantity Theory of Money?
The quantity theory of money is a classical economic theory stating that the price level in an economy is directly proportional to the amount of money in circulation. It is expressed through the Fisher equation: MV = PQ, where M is the money supply, V is the velocity of money (how frequently each dollar changes hands), P is the average price level, and Q is real output of goods and services. In its simplest form, if V and Q are stable, doubling the money supply will double prices. The theory underpins monetarism and was championed by Milton Friedman, who stated that 'inflation is always and everywhere a monetary phenomenon,' meaning persistent inflation requires persistent money supply growth.
Example
Following massive monetary expansion during the COVID-19 pandemic, U.S. M2 money supply grew roughly 26% in 2020 alone. Consistent with the quantity theory, inflation eventually surged — with CPI reaching 9.1% in June 2022, the highest in 40 years — as the expanded money supply outpaced real output growth, though with a lag explained by initially falling velocity.
Source: Federal Reserve Bank of St. Louis — FRED M2 Money Supply