What Is the Connection Between Money Supply and Price Level?

The total price level refers to the weighted average level of prices of all goods and services in the whole society within a certain period. Regulation of the overall price level refers to the state's direct or indirect intervention and restraint on changes in the overall price level through economic, legal, and administrative means to ensure the realization of the overall price level control objective. ^[1]

Total price level

Money Supply, Money Circulation Speed and Total Output

If M represents the quantity of money supplied in a certain period, V represents the speed of currency circulation, P represents the total price level, and T represents the transaction volume of various commodities, then:

MV = PT or P = MV / T

It can be seen from this equation that the value of P depends on the correlation between the three factors M, V, and T. Among these three factors, M is determined by factors outside the model, V is relatively stable over a certain period of time, and T's growth is relatively stable, so the price change depends mainly on the change of M.

If the above formula is derived by the differential method, the determining equation of the total price level can be obtained, namely:

= m + uy

Where represents the total price level

In market activities, economic variables in the form of wages, interest rates, exchange rates and other monetary variables have an interactive relationship with the overall price level. When the overall price level changes, these economic variables will be affected and adjusted accordingly.

The total price level not only has a direct impact, but also an indirect effect, mainly including the impact on the production decision of the enterprise, the impact on the income distribution structure, and the impact on economic growth.

Generally speaking, changes in the overall price level, particularly drastic and large-scale changes, are not conducive to economic growth. Only in the short term, when price changes are not expected by market entities, can certain effects on economic growth occur. Inflation is conducive to economic growth to a certain extent, while deflation is not conducive to economic growth to a certain extent. But this effect is only temporary.