About the writer
Great post. One thing I don’t get:
“V may decrease in since people have higher demand for money now (as more money is required to continue to buy the goods they desire at the increased price level).”
Can’t an argument be made for V being higher since more money is needed to transact?
Thanks @block. You bring up a good point. Per QTM, when money supply increases, neither velocity nor real GDP get significantly affected, so prices increase proportionally and everything else stays the same.
According to Keynesian interpretation of EoE, however, people also have precautionary and transitionary demand for money. When money supply increases, interest rates typically are lower as the Fed is trying to stimulate the economy. When interest rates are lower, the opportunity cost of holding money is lesser (you are not losing out on much interest by keeping it liquid). At the same time, because there is more money now, value of unit money goes down, which means people need more money for transitionary purposes to procure the same goods/services that they did earlier. So they are more inclined to hold more money liquidly in hand for these transactions rather than invest it in financial interest-generating assets, thereby decreasing velocity. Hence velocity is said to be inversely related to money supply.