Implications of a Flex-Price Quantity Theory

The current GDP deflator should be 18% higher (in log terms), or 154.2 instead of 128.2. To see this, consider the tautology:


Where M is money, V is velocity, P is price level, Q is economic activity.

Assume V’ is constant; then:

MV’ = PQ

In 2019Q4, V for M2 was 1.4245. Take logs (where lowercase letters denote log values).

p = m + v’ – q 

Taking this manipulation literally, one obtains the following picture.

Figure 1: Log GDP deflator, 2012=0 (blue), and log M2 x V’/GDP where V’ takes on a fixed value of 1.42 (recorded on 2019Q4) (tan). GDP in bn Ch.2012$ SAAR, M2 in bn$. NBER defined peak-to-trough recession dates shaded gray. Federal Reserve, BEA via FRED, NBER, and author’s calculations.

The 2022Q3 GDP deflator was 25% higher than in 2012, while using the 2019Q4 value of velocity, the GDP deflator should have been 43% higher (in log terms), had the flex-price quantity theory held.

If you were wondering, there is little evidence of stability in velocity (either mean or trend stationarity). The Johansen maximum likelihood approach to testing for cointegration shows no evidence of a long run relationship between the GDP deflator on one side, and M2 divided by real GDP on the other (the tan series in Figure 1) over the 1960-2022Q3 period.


40 thoughts on “Implications of a Flex-Price Quantity Theory

  1. pgl

    Not to go off topic but this story about the pathetic lies made by Hershel Walker have hit a new low:

    Republican Senate candidate Herschel Walker has been met with an angry response online after he accused Democratic Senator Raphael Warnock of being responsible for abuse at a youth camp. The video of Walker’s remarks shared to Twitter has now been viewed more than 400,000 times, with some social media users strongly criticizing the Republican and suggesting his comments were defamatory. The footage was shared on Monday by Twitter account PatriotTakes, which describes itself as “researchers monitoring and exposing right-wing extremism”. It also said Walker’s comments as “a potential defamation lawsuit.”

    Of course the Republicans tried this stunt during the 2020 Senate elections and the accusations were thoroughly discredited. Now I get the right wing Trumpians have no bottom so they got their “boy” to rehash these vicious lies as some new discover. Hershel Walker does not deserve to be in the Senate but he should be sent to jail.

  2. pgl
    Velocity of M2 Money Stock

    From 1959 to 1991, Velocity hovered around 1.8. For our hard core Know Nothing monetarists (Bruce Hall, Princeton Steve, and even good old worthless Econned) why not take this higher figure and really go CRAZY?!

    Of course even Milton Friedman abandoned this junk science. But not our Usual Suspects!

      1. pgl

        The Global Warming model of inflation? Damn Bruce – we did miss your incredibly STUPID comments. Welcome back from those North Georgia KKK meetings!

      2. pgl

        Hey Brucie – I have been reading on William Meyer – the nutjob who writes your favorite stupid blog. OK – he likes Wiley Coyote, which is cool. Now is this cartoon character your new expert on macroeconomics and climate change? That would be a vast improvement on your previous expert sources.

        1. pgl

          I never read Brucie’s little blog. Are all the posts there as disjointed and utterly pointless as that particular one?

  3. pgl

    One thing about the very recent behavior of M2 – which is something your graph notes – is that money has of late been declining. So why we are arbitrarily picking some value of “velocity”, why not pick the value for the end of 2021. Would this new QTM version 8.0 tell us we should be having DEFLATION? Like – let’s really go CRAZY while we are at it!

  4. Macroduck

    Hence the Fed’s interest in asset prices, FX rates, the workings of credit channels, the Phillips curve, interest rate targeting rather than M1, 2, 3 or Z targeting…

  5. Moses Herzog

    Any of you folks ever seen “Hobo Shoestring” on Youtube?? He is one cool dude and if you have some free moments go on and check him out. His latest upload has the Santa train and Jaw Tooth.

  6. Not Trampis

    assuming V is constant?? Has it ever been?

    I always thought the demand for money function was highly unstable as well

    1. pgl

      Back in the day when I was in graduate school, we were asked to read over a paper than talked about the Mystery of Missing Money, which was basically an observation that the demand curve for money unexpectedly declined. Maybe Dr. Chinn remembers the exact cite as when I go to Google with this title, all I get are kids games and books.

          1. Moses Herzog

            I guess I’ll have to try to look that paper up. Maybe it’s just pay-walled in some journal. I’ll look it up so I can mentally beat myself up when 80% of it flies over my head. If I find the paper I’ll put it right here in this part of the thread.

          2. Moses Herzog

            I just noticed something while wandering around Brookings. Is Christiane Baumeister the wife/daughter of the Baumeister of Baumeister and Blinder textbooks??

        1. Barkley Rosser

          The period when there was a serious argument that V of M1 might be more stable than the MPC was in the 1950s and 1960s when people like David Meiselman of VA Tech, a student of Milton Friedman’s, was debating this with the late Don Hester of UW-Madison, who was a student of Jim Tobin’s.

    1. pgl

      Gee Johnny boy seems worried that the ruthless government of Iran might not be able to give Putin more drones to kill innocent Ukrainians. I guess Johnny boy does not care about the people of Iran either.

    2. JohnH

      Another example of selective news coverage: big brouhaha about armbands at World Cup, almost nothing about protests in Europe. I mean armbands????

      1. pgl

        I bet you would jail athletes who stand up for the rights of women in Iran. Yes arm bands so these athletes can do something you are incapable – competing at a world class level.

        Speaking of athletes and human rights – I bet you have begged Putin to make sure Britney Griner suffer as much as possible so you can enjoy her suffering. You are that kind of dude.

      2. pgl

        Hey Johnny – did you read a title and not the story. It seems the protestors are calling out you and your boy Putin:

        BERLIN (AP) — Tens of thousands of people rallied Sunday in cities across Europe to protest against Russia’s ongoing war in Ukraine, with small vigils taking place in Russia as well despite a crackdown by authorities against such demonstrations. German trade unions called a protest in Berlin, where sunny weather boosted the turnout. The march led from the city’s Alexanderplatz — a large square named after Russian Tsar Alexander I — to a site near the Brandenburg Gate. Many participants carried flags in the blue and yellow colors of Ukraine, while others bore banners reading “Stop the War” and “Peace and Solidarity for the people in Ukraine.” Norbert Herring, who held up a sign that read “What are you doing to your neighbor?” as the crowds filed past the Russian Embassy, said the images from Ukraine reminded him of the bombing of cities during World War II.

        It seems you have totally misrepresented something once again. I don’t know. Are you THIS dishonest? Or are you really too STUPID to read past the headline which you clearly failed to comprehend?

        1. Barkley Rosser

          Not to mention that the FT is “mainstream media,” so his complaint that these things are not being covered in “mainstream media” was disproven by his own link. He has a way of not reading them all that carefully sometimes, or, perhaps, deliberately misrepresenting them. Given his abysmally immoral track record, the latter is highly likely.

    3. pgl

      I did get by the FT wirewall to read Johnnny boy’s story which included this:

      Most are attended by a few hundred people, many by just dozens. But as with similar rallies elsewhere in central and eastern Europe, they point to a worrying trend for the region’s political mainstream. Several thousand protesters including groups from the far-right and far-left take part in a rally in Prague in September

      Dozens of rightwing lunatics? Even a recent Trump rally does better.

      Come on Johnny boy – your attempts to bolster Putin’s war crimes are getting quite pathetic.

      1. Barkley Rosser

        It had its heyday in the 50s and 60s and even into the 70s a bit. Then it began to fall apart, becoming basically completely discredited after the mid-80s.

        Of course the “theory” is a tautology as in simply noting that MV = PQ (or PT if you prefer). What once could have been taken seriously, and successful anti-inflationary policies without holding back growth were used following it in the 50s and 60s in places like Switzerland and West Germany, was the twin assumptions that V is relatively stable and that M is independent of Q, certainly in the long run. When those broke down, especially the former, the garden variety Friedmaniac “quantity theory of money” was kaput, which even Friedman himself admitted before he died, as has been noted here several times by several of us.

  7. pgl

    During the first 3 years of the Trump dictatorship, GDP/M2 (velocity) averaged 1.444. Velocity had declined from almost 2.2 during Clinton’s first term to less than 1.5% by the time Trump replaced Obama. So I guess if one were a MAGA hat wearing fool, one might praise Trump for stopping the Socialist decline in velocity under Clinton, Bush43, and Obama.

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