MV = PY
where M is the amount of money in the economy; V is the velocity of money and it’s just a measure of the number of times a cedi note changes hands (In other words, it’s a measure of the rate at which transaction takes place); P is the price level of the economy; and Y is the real GDP or output level of the economy (normally called the economic pie). Y includes all final goods and services produced in the country.
(Aside 1: the money equation was proposed by Milton Friedman and is popular because of its intuitive appeal to non-economists: It’s straightforward to verify that if you multiply the amount of money in the economy by the rate of transaction, you should get the nominal value of all goods and services produced in the country)
I would tell the politician that if you mathematically manipulate the money equation, you find that:
% change in money + %change in velocity = % change in price + %change in output
(Aside 2: transaction rate typically doesn’t change by much so we normally assume the % change in velocity is 0; however, other external factors that seem to reduce transaction costs, like redenomination, may effectively increase velocity.
Notice also that percentage change in price is commonly called rate of inflation and percentage change in output is called economic growth rate)
By Aside 2, we could re-write the above equation as:
% change in money = inflation rate + economic growth rate — ***
I would therefore interpret *** to politician that any time he decides to print money (to celebrate a national birthday, put into his/her pockets, or finance an election), he/she should know that it manifests as inflation and economic growth. However, he/she should not be deceived by the economic growth since it’s just for only a short period (though inflation lasts forever and might even get worse).
At this point, the politician might be confused about why the economic growth is ephemeral but the inflationary effect is everlasting. Then I would tell him (maybe after charging him a little token for consulting or do it for free because of the love for my country), that:
The temporary economic growth we see is because some prices take longer time to adjust: Typically, wages and contracts are negotiated on long term basis. Thus, a sudden increase in money supply may cause output prices (like computers, foodstuffs, etc) to increase since more money in economy means higher demands for goods and services; on the other hand, workers who have already negotiated their wages may unfortunately not get a wage increase until their contracts expire and they get to re-negotiate. With rising prices of final products and costs of labor remaining the same, producers would increase their production and thereby causing economic growth in the short term. The magnitude of the economic growth, by ***, equals the difference between growth rate of money and inflation rate.
However the life of this economic growth is as long as wages remain fixed. In the long term, contracts expire, wages get re-negotiated and the effect of the increase in money supply is completely manifested as inflation; thus inflation worsens with time.
Now the politician would go: “so what’s the biggie? I print 10% more money, I get 10% change in price levels and 0% growth in the long-run?”
Then I will respond:
Inflation is an economic bad so the lower you keep it the better for your people. Secondly, the story doesn’t end here at all!!! People in the economy would now perceive the government as monetarily undisciplined and to be printing more money in the future. Hence, they would be expecting future prices to increase. Producers, with this expectation, would hoard their goods so they could sell later for higher prices; this decrease in supply would cause prices to go up! Consumers, wanting to avoid higher prices in the future, would buy more goods to save for tomorrow; this increase in demand causes prices to rise up even more.
I would finally say to the politician:
“So you see, Mr. Politician, printing money doesn’t only cause substantial inflation.
However, it results in a culture that causes this inflationary effect to perpetuate and possibly yield hyperinflationary economy like the 1000% inflation rate observed in Zimba……[no names]”.
After here, any extra word I say would be charged.
Phew! That took more than five minutes …right. Don’t be surprised, I was dealing with a politician.
So who is the politician I am talking to? It’s you. Please remember the money equation if you get the chance to lead Ghana sometime in your life. If you however don’t, please vote for the guy who takes the money equation seriously.
Milton Friedman, says it best, “Inflation is always and everywhere a monetary phenomenon!”
Yen ara Asaase Ni and our destiny lies in our Hands.
By Gyasi K. Dapaa