Money Supply

Quantity theory of money suggests that excess growth in money supply leads to inflation.

where:

• is the money supply measured as M3;
• is the velocity of money
• is the price level, measured as the whole of economy price index as the implicit price deflator; and
• is the volume of transactions proxied as real expenditure using chain volume GDP.

The following formulation, in growth rates, has been widely used in empirical tests

where represents the 4 quarter log changes. Assuming the velocity of money is stable, the equation simplifies to

The relationship between the left and right hand sides of this equation for Austalia since 2006 is shown in the chart below.