The Endogenous Money Supply

Abstract

The traditional quantity theory of money has a long history going back, at least, to the eighteenth and nineteenth centuries. It states that the total output of goods and services produced in an economy, within any given period of time (for example, one year), can be expressed in two equivalent ways. From the ‘goods’ side, total nominal output (Y) is simply the sum of all goods produced in that period multiplied by their respective market prices; that is, Y = PQ where Q is the total real output of goods and services and P is the general price level consisting of the set of individual prices corresponding to the myriad components of Q. Alternatively, from the ‘money’ side, this is equivalent to the aggregate money supply (M) multiplied by the average number of times each unit of money turns over in a year’s time; that is, the income velocity of money (V). In short, Y = MV. If Y = PQ and Y = MV then it follows that MV = PQ