What is the quantity theory of money?

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pohnpei397 | College Teacher | (Level 3) Distinguished Educator

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The quantity theory of money is a theory that is the basis of monetarist ideas like those of Milton Friedman.  The quantity theory of money holds that there is a direct relation between the quantity of money in an economy and the price level in that economy.

The theory asserts that the equation MV = PT is true where M is the quantity of money, V is its velocity (how often each dollar changes hands), P is the price level and T is the number of transactions. Monetarists hold that V and T are constants, at least in the short term, which means M and P are directly related.

Monetarists use this theory to argue that the money supply should be carefully managed to prevent inflation since increases in the money supply do not lead to economic growth.

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