11/29/13

One Horse Trick

A (Most Likely Incorrect) Thought Experiment (Ridiculously Wonkish)




My favorite way to approach economics (as I've written about here, here, and here) is through the equation of exchange, MV = PQ: money, multiplied by its velocity, is equal to price times the quantity of real output an economy produces. It's my favorite approach because it's both simple and complicated, obviously true but also open to interpretation. 

One of the common ways to interpret this deceptively simple equation is Milton Friedman's way, which is, in a nutshell, to assume that M has a one-to-one impact on P, and no impact on Q. Hence, monetarism. Milton based his interpretation partially on the interpretation of philosopher David Hume, who, writing before the relationship between money, velocity, price, and output had been formalized into an equation, argued that a change in M should only affect only P with a thought experiment: if everyone in England woke up one day with twice as many coins in their pocket, prices would change, but nothing else.