What do economists mean when they say that monetary policy can exhibit changes in velocity?
If we take the basic quantity of money theory, we have M.V = P.Y M=Money supply V = Velocity of money (how many times a single unit of currency is used) P = average price level Y = Income Monetary policy changes the level of M in an economy. If we then look at the Keynesian expansion of this we see that Velocity = Function of (interest rates, Income) – meaning that interest rates and income determine the value of velocity. As monetary policy works by changing the level of money in an economy, basic economic theory says that the quantity of money and interest rates are going to be inversely related (the higher the money supply the lower the interest rates).
