Is Inflation Always And Everywhere a Monetary Phenomenon?

Yesterday, I asked:

It is true that the equation I am referring to — MV=PQ, where M is the money supply, V is velocity, P is the price level and Q is output — is not exactly Friedman’s equation. It was initially theorised by John Stuart Mill, and formulated algebraically by Irving Fisher, but adopted by Friedman and his monetarist followers to the extent that Milton Friedman had it as his car number plate:


MV=PQ itself is a tautology that ties together three disparate variables — the money supply (M), the price level (P) and the output (Q) — by creating a quantity — velocity (V) — that is not observed directly, but is instead computed retrospectively from the three other variables. But, nonetheless, so long as we can overlook the fact that V is not directly observed (which ultimately we should not, but that is another story) it is true that MV=PQ accurately describes monetary reality.

Friedman’s famous quote seems to contradict his beloved equation:

Inflation is always and everywhere a monetary phenomenon, in the sense that it cannot occur without a more rapid increase in the quantity of money than in output.

Within the parameters of the equation, an increase in P can come from any of the other three variables in the equation — all else being equal a decrease in Q, or an increase in M, or an increase in V.

The only way that Friedman’s statement could be true is if V and Q were stable. Friedman did actually claim that V was largely stable, but empirical data rules this out. Here’s velocity:


And here’s output:


Neither of these are constant, or even particularly stable, meaning that it is impossible within the parameters of Friedman’s own equation for inflation (changes in P) to solely be a monetary phenomenon. Inflation by Friedman’s own mathematical definition is a result of a combination of factors. And in the real world, it is far, far, far more complicated — a price index generalises a staggering array of human actions, each one the outcome of an equally vast array of psychological, social and economic influences.

68 thoughts on “Is Inflation Always And Everywhere a Monetary Phenomenon?

  1. You might find this post from the Arthurian interesting

    as he puts it

    “Sometimes, though, writers leave out a word here and there. I do. In my previous post I wrote, “The tweak shows that money increased more quickly than prices.” What I meant was, “The tweak shows that ‘the quantity of money relative to output’ increased more quickly than prices.” Taken literally, the difference is significant. But extra words weigh down the thought and make it more difficult to toss and catch.”

    “Writers leave out words sometimes. Friedman left out the word substantial. Not every time. But enough that the lighter phrase caught on. People say, “Inflation is always and everywhere a monetary phenomenon.” Friedman said “substantial inflation is always and everywhere a monetary phenomenon.” He even put it in italics.”

  2. actually the equation was formalized by Simon Newcomb.

    also, the equation is only a truism if you define the variables right. it’s also meaningless. velocity is just an empty variable that justifies a monetarist’s lack of understanding of money.

  3. Your assertion requires that Friedmann say that inflation was EXCLUSIVELY a monetary phenomenon. He didn’t.

  4. Is there a correlation between V and Q? I can imagine that lower velocity will cause less production. Central Banks try to compensate by increasing M. My feeling is that this working partially and temporarily. Q will increase a little for a while, but rising prices will stop this phenomenon.

    And people are still in a depression mindset. Human action reflects this as Mises wrote.

      • “Even if this were true, it would still be faulty to explain the purchasing power–the price–of the monetary unit on the basis of its services. The services rendered by water, whisky, and coffee do not explain the prices paid for these things. What they explain is only why people, as far as they recognize these services, under certain further conditions demand definite quantities of these things. It is always demand that influences the price structure, not the objective value in use.” (Human Action, p. 400)


        “The main deficiency of the velocity of circulation concept is that it does not start from the actions of individuals but looks at the problem from the angle of the whole economic system. This concept in itself is a vicious mode of approaching the problem of prices and purchasing power. It is assumed that, other things being equal, prices must change in proportion to the changes occurring in the total supply of money available. This is not true.”

        According to Hazlitt, velocity of money has no effect on prices. It is fear that inflation will continue that increases the velocity. Prices don’t increase as much as new money is created. When this new money is circulating in the economy for a while, prices will rise even faster than the percentage of new money.

        According to the Austrians, it is a monetary phenomenon, velocity is irrelevant.

        • “Velocity” is a fudge, it’s much more complicated than that. As I state:

          And in the real world, it is far, far, far more complicated — a price index generalises a staggering array of human actions, each one the outcome of an equally vast array of psychological, social and economic influences.

          Prices change for a vast variety of reasons, many of them social and psychological, as well as economic and monetary. If Mises thought price changes in general (or inflation in particular) are a purely monetary phenomenon, then I would say that that is inconsistent with some of his other ideas, which emphasised the multivariate nature of human action.

        • A more useful form of the equation is the dynamic form

          m’/m +V’/V = p’/p +Q’/Q If, for a period of time, money growth exceeds real growth such that

          m’/m – Q’/Q = c then it must be true that p’/p – V’/V = c as well. In ordinary language, this means that when a glut of money chases a dearth of goods, the price increases will cause the goods to sit on the store shelves until the clearance sale, even if some store employees have to be laid off.

      • Yes, I looked up money supply and the other components of that formula. Not only is there no agreed-upon definition of effective money, but it seems there is a lot of disagreement about what ‘velocity’ means, as well, or how it is to be measured. Hence it seems the style of MV = PQ is a sham — it imitates E = mc^2 and f = ma, but these are about well-defined quantities, not vague approximations of one knows not quite what.

        • The key difference between E=MC² and MV=PQ is that all the variables are observable (and thus testable), and not calculated retrospectively from the other variables.

  5. Bring in the mathematicians!

    When people refuse to believe that which is staring them in the face, they resort to lower forms of processing, i.e., intellectualization; and if mathematics is not the lowest form of this synaptic alchemy, I am not sure what is.

    Beyond understanding that inflation is an increase in money/credit relative to output, attempting to figure out the variables involved would be like observing Niagara Falls and attempting to predict the interactions of each water molecule as it comes over the falls.

    The point is that it does not matter and in the case of economics, these apparitions are just that, methodology to distract people with ideas [no matter how lame] so that they can better rationalize the essence of this and all systems, thereby securing their rightful place in their hierarchy of thieves [e.g., Paul Krugman].

    • I rise in defense of mathematics! As Anarc pointed out, an equation, a proper and useful mathematical form, can be valid or a sham depending on its terms. As usual, the youthful (to me) geeks caught the essence with “garbage in, garbage out”.

      • DG, of all the gods to prostrate before, thou hath chosen, Lord Mathematicus.

        My heart goes out to you and others who must kowtow to His imaginary numbers, fanciful formulas, and theatrical theorems. And to those who feel it necessary to add, subtract, multiply and divide, I pray for your very souls, that you will not be cast-off into analytic purgatory where you will spend all eternity trying to figure out why this great religion fails the faithful as ‘0’ and infinity are approached.

        + – = x / + – = x / + – = x / + – = x / + – = x / + – = x / = – = / x / + –

        • I shall be watchful for the dire fate of which you warn! Golly, I thought I was OK as long as i didn’t break THE commandment: “Thou shalt not divide by zero!”

        • I love math, and generally think the principles of mathematics are some of the highest gifts of civilisation.

          But in the real world, it is only useful when you’re using it with observable, testable quantities. This means that it is inherently of limited usage in the social sciences. Very often, social science applications of mathematics are garbage in, garbage out applications.

        • John and others,
          I hope you do not take my rants all that seriously, but you have to laugh at what we humans take as the truth. I understand that math does have applications in the real world, but I try as hard as I can to avoid that world at all costs.

          Math just happens to one of those areas where it is really easy view the duality that characterizes all things knowable.

          And, fwiw, zero is an abstraction that can not be defined.

  6. John, I believe you have stumbled into “Einstein” moment. Observations like: “in the real world, it is far, far, far more complicated” “staggering array of human actions…..vast array of psychological, social and economic influences” cannot be ignored just because they are difficult to quantify and have yet to be assigned a value. The day is here when 1+1 does not always = 2.

    I believe we are entering a time of virtual economics where perception easily becomes reality and the psychological, spiritual acceptance of “it is what it is” has filled the gap created when advances in technology and science eclipse the ability of traditional philosophy to explain our existence and purpose. “Pop Culture rules”.

    It is not that empirical evidence plays less a role, but that technology has expanded the view ( Hubble vs Mount Palomar ).

    This is why I believe mainstream economic models and a framework of capitalism vs socialism are obsolete. We are living in the throws of the past propelled by interests (mostly old men) who refuse to change (or die).

    Current economic theory and models need to evolve, but most likely will have to quickly morph into something different. I hoped you might have recognized my comments over the past few weeks as not just rantings but the thoughtfulness of an old man who believes there is a future.

    Not knowing where my thoughts would end, I stole lessons from the sciences of cosmology and physics that some claim is the foundation for civilization now that philosophy has taken to riding in the back of the bus. Those sciences accepted a principal that allows theory to move forward at times when our understanding prevents the numbers from adding up.
    I think it applies to economics as well.. The Anthropic Principal states: We see the universe the way it is because if it were different we would not be here to observe it.

    • “The Anthropic Principal states: We see the universe the way it is because if it were different we would not be here to observe it.”

      In other words, A = A, because I can’t make sense of anything what-so-ever, so I have to make up some absurd theory to tell everybody something they already know.

      [El Zombo, this comment was not directed towards you, but instead, towards [groups of] people who feel as if they must say something instead of just accepting things the way they are [without comment].

      • Imp, old friend: no doubt the wrong position in the thread, but I must saythat your thinking is intriguing! I love your reminder that the only things knowable in economics are between one buyer and one seller; but you confuse me with “Simplicity is truth”, rather than “Truth is usually simple”.

        What’s the mystery about zero? The word and mathematical symbol is as concrete as one, two, minus one, etc. And how does mathematics reveal “the duality that characterizes all things knowable”?

        • “…but you confuse me with “Simplicity is truth”, rather than “Truth is usually simple”.

          Absolute simplicity [that which is unknowable] is Absolute Truth [that which is unknowable]. As things [intellectual] become more simple, they move closer to the truth. As things [intellectual] approach total [or absolute] simplicity, you have arrived at the truth.

          “What’s the mystery about zero? The word and mathematical symbol is as concrete as one, two, minus one, etc.”

          Well, then what is zero? In that all things in the knowable Universe are unique, what does two mean?

          “And how does mathematics reveal “the duality that characterizes all things knowable”?”

          Duality characterizes things knowable, that is, the relativity of all things. Mathematics makes this duality obvious. For instance, “one” implies that there must be a, “not one.” But, of course, this is impossible, as all things knowable are unique.

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  8. Velocity means the speed at which money changes hands because people perceive that it is losing value so they purchase real assets with paper money. However if true why would people accept this paper money in payment for real assets if they too feel that it is losing value?

    • Well, I’d say the real problem with velocity is that it’s a generalisation. That is, the figure given speaks about how much the entire stock of money has changed hands. With trillions and trillions of dollars, this generalisation fudges over the real complexity of human monetary behaviour.

      • I think Austrians say that velocity cannot be measured because it is too complex as you say and this is exactly why it is dangerous when central planners are printing so much money….they have no way of knowing if velocity has increased or not. Perhaps all these problems will be eliminated for the central planners when we only use electronic money…they will be able to track all transactions. Even Africa is being prepared to receive an injection of money for development which will allow them to buy US debt and finance another round. Perhaps we are witnessing the birth pangs of a world government.

        • “tracking money” In response to the problems encountered in the virtual economy, technology will be able to track and report consumer purchases on a “real time” basis. Prices for goods and services will change up or down continuously based on the info (much like the pricing schemes used by airlines). How and who this will benefit is up for debate.

    • “Why is money accepted for payment for real assets” The money is used to purchase more real assets hoping the asset will appreciate as an inflationary hedge. Hence money as the hot potato that gets passed along creating more velocity. (money burning a hole in my pocket) Looks like behavioral economics to me….

  9. Hi aziz,
    I`ve a couple of questions, why was the velocity of money steadily falling from the 1880`s til the 1940`s. Was it measured before the 1880`s? and why did it rise in the post WWII era. And what if any effect does the ever increasing taxation leavied by our governments have on this. I would suggest as taxation increases it reduces the velocity of money as less is left to flow around the system?, though I`d ask

    • I would argue that velocity of money is higher because of taxations. Governments don’t save, they always spend the money they collect.

      • Falling velocity is correlated with rising debt in the long term leverage cycle. Once a Minsky moment is hit, velocity may soon bottom out, and once the deleveraging is done and the economy is recovering, velocity may start to rise again.

        That’s the correlation, anyway. The causation may be harder to unpick. It is a chicken and egg dilemma — does rising debt cause falling velocity, or vice versa, or are they both reacting to another parameter?

        • V = i/((1-u) or velocity is interest divided by either debt or savings. For a constant interest rate, there is an infinity of V and (1-u) which correspond. You can have high velocity and low debt or low velocity and high debt. If you graph V vs (1-u) you get an asymptotic hyperbola for a constant rate of interest.

        • Those correlations are theoretically possible, but we don’t tend to see them much in actual data… Look at Japan… High private debt tends to be a massive decelerating force.

        • Supposing that debt is money (an idea I get from W.F. Hummel) then increasing debt increases the supply of money, lowering the velocity required for the same number of transactions.

    • I believe the “falling velocity 1880’s through beginning WWII” was made possible by a predominant decentralized economy and the ability of commerce to move underground perhaps in response to avoiding taxes.. (post civil war south)

    • The basic reason velocity fell from 1880 to 1940 is that the banks were creating excess credit which was flowing into low velocity speculative ventures such as land and houses. The real growth rate of the US economy is around 4.5% but the interest rate was bid up to 8-9% .

      Since m’/m -Q’/Q = .04 so that p’/p – V’/V = .04 or V’/V = p’/p – .04 Since the price level was controlled by the gold standard p’/p was about .01, so V’/V = -.03 . This gives

      V = 5*exp(-.03*t) which doesn’t fit the curve well at all. The explanation is that in the decade
      1890-1900 there was 12% unemployment which caused velocity to be in a free fall. Other factors which caused debt accumulation and lowered velocity were WW I, followed by the Depression of 1921, the Great Depression, and WW II.

      • After 1945 and Bretton Woods, where the dollar was declared the world reserve currency at $42/oz gold, the dollar was kept strong by interest hikes which revived velocity. After 1971 and oil price shocks, the Fed spiked the Fed Funds rate to squeeze out inflation. In 1979-83 Volcker raised the fed funds rate to 20% which was such a cost shock that unemployment rose to 12% and output fell as a result.

        • The interesting thing for me is that velocity trajectories tend to be long-term phenomena, just as debt trajectories over their full cycles are long-term phenomena. These trends are much longer than what is commonly called the business cycle…

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    • I do briefly sound a bit like a praxeologist here, I’ll admit. When it comes to actual economic theory some of my ideas are pretty close to Mises (though some of them are more Feketean, some of them more Minskian). Difference is that I think it’s much more possible to test things empirically nowadays than it was during Mises’ time (behavioural economics is a massive step forward for empiricism), and I don’t rule out certain emergent phenomena in macroeconomics that cannot be microfounded in individual human action (just as some phenomena in, say, biology cannot be microfounded precisely in quantum physics).

      • “It’s much more possible to test things empirically nowadays” Exactly… We have the technological ability…. Einstein’s frustration at his failure to move forward with a unified theory was due largely to the limit technology put on his ability to observe.

        • “It’s much more possible to test things empirically nowadays”
          Exactly… We have the technological ability…. ”

          This is, perhaps, the ultimate fallacy, that we can prove things, empirically. If people understood the true nature of phenomena, then they would not fall for all the voodoo and witchcraft that define social man.

          Simply stated, it is impossible to access reality, intellectually.

        • “are we any closer to a unified theory” … The increased ability to observe has shown that there are many more pieces to the puzzle than Einstein could have imagined. ( this supports the comments of “impermanence”). That does not diminish the frustration Einstein felt by not being able to try, or make futile the attempts by economists to better understand behavioral economics. Observation leads to theory and back to observation for validation. (kind of a vicious circle) It does explain the need for Prozac……

      • You macroeconomics scholars/thinkers seem to identify more uncertainty/less confidence the farther you explore from the “micro”/real world. This evokes any number of fascinating discussion topics — reconciling quantum theory with relativity, why predictable antHILL behavior vs. unpredictable individual ant, short-term vs. long-term predictability of various phenomena, etc. But, for us practitioners, how about some recent history and prediction of real world inflation — from food to government fantasy/fabrication?

        • To clarify: my first use of “real world” (after “micro”/) — “testable”, a term used above, would have been better.

        • DG, as you seem to intuit, the only thing we can know about economics is the relationship between a single producer and a single consumer [simplicity is truth].

          Taking economics to the group level [complexity] is like attempting to understand the relationship between a man and a woman in the context of a group. Imagine having a society where the elite tell you that your wife is really not all yours, so you don’t mind if I take her over to my house tonight, do you?

          This is what happens in economics when the elite tell you that your labor-value earned is really part theirs. Their economics makes no sense because they are simply stealing.

  11. Given that no one has demonstrated that the remaining two variables (Output and Velocity) can be stated in terms only of Money Supply then as you suggest Friedman’s statement has to be accepted as false on its face. Otherwise someone would have done the math long ago proving it out.

  12. I collect shopping dockets of generic products. Just to see if the CPI matches the pension or welfare CPI. I love proof when waving it in front of silly Politicians.

  13. CPI should be based on generic goods that enable one to survive. Then wages indexed according to that number. There is no point in indexing wages to non essential and luxury goods. If those goods become to expensive, demand is elastic and will stop purchasing.

    Electricity Gas, Water and other utilities should be based on the lower tariff, not the higher tariffs associated with excess usage.

    Once we have the numbers we can correctly index pensions with an essentials CPI.

    I am frustrated with Unionist demands for higher wages, when their current wage is well over the poverty line. They have excess savings that is exponentially increased by getting higher and higher, over the CPI.

    There must also be stricter rules in the media for discussing Unemployment and CPI numbers as this causes wage demand inflation. If Unionists knew the real level of CPI and the real unemployment rate (For full time secure workers) then they will no be so pushy in wage bargaining.

    And I am a firm believer from the lessons of the Weimar republic. If you are going to halt production and borrow money from overseas lenders to pay your workforce not to work, expect hyper inflation.

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  17. Well, general inflation, within a currency, is always and anywhere, there, a monetary phenomenon, although the timing may be such that it does not occur as inflation.
    Loads of money may be held inactive or transmute into slow markets as securities which are held, or partake in other markets than of the chief domain of the currency, where inflation may be seen in the currencys´value, but which transactions there do not reflect back properly into the calculus.There may also be recession hidden under inflation which both then are not visible, and so on. When inflation is a fact, then the brakes will be monetary once again.

  18. Just a small correction it was Newcombe who first algebraically expressed the equation of exchange, about 40 years before fisher, although their were many crude versions from about the 1840s onwards

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  21. Thats assuming that he believed in the MV=PQ. His actual version of the quantity theory of money was “M^d/P=k(Yp)” where ‘Yp’ is permanent income. His model is also for long run. This is a bit different than the quantity theory of money that you proposed.

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