The 8½ Equations Version of the Quantity Theory of Money

This article addresses the low inflation rates of recent years in the light of expansionary monetary policy. Building on essential macroeconomic relationships we present a modern version of the quantity theory of money. At low rates of inflation, an expansionary monetary policy can induce an increase in the money stock not matched by a corresponding increase in prices. When money demand is very elastic – a liquidity trap effect – real money balances can increase by 100 percent or more. The key to this phenomenon is the insight that a peg of the policy interest rate at a very low level does not lead to accelerating inflation.