In order to explain the link between inflation and the money supply, economists use what's called the quantity theory of money. It centers on the Quantity Equation. This basically says that economic output (gross domestic product) is equal to how big the money supply is, this is multiplied by the velocity of money, which is how many times the same dollar gets spend throughout the year. Real GDP is equal to how big the money supply is I multiplied by the velocity of money. In macroeconomics it boils down to that the money supply times the velocity of money is equal to the price level times the nominal GDP. For example: suppose your price level is 1, while nominal output is $200. The money supply is $100. When using the above formula basically it means that the average dollar bill in circulation is getting spent two times during the year because if you work out the velocity it comes to 2. Another way of looking at this is that money is turning over at a rate of two times per year. If the central bank decides to doubles the money supply from 100 to 200 dollars while the nominal GDP and the velocity of money stay the same it would mean that the price level will now double. When the central bank increased the money supply by 100
In order to explain the link between inflation and the money supply, economists use what's called the quantity theory of money. It centers on the Quantity Equation. This basically says that economic output (gross domestic product) is equal to how big the money supply is, this is multiplied by the velocity of money, which is how many times the same dollar gets spend throughout the year. Real GDP is equal to how big the money supply is I multiplied by the velocity of money. In macroeconomics it boils down to that the money supply times the velocity of money is equal to the price level times the nominal GDP. For example: suppose your price level is 1, while nominal output is $200. The money supply is $100. When using the above formula basically it means that the average dollar bill in circulation is getting spent two times during the year because if you work out the velocity it comes to 2. Another way of looking at this is that money is turning over at a rate of two times per year. If the central bank decides to doubles the money supply from 100 to 200 dollars while the nominal GDP and the velocity of money stay the same it would mean that the price level will now double. When the central bank increased the money supply by 100