Monetarist Arithmetic at COVID-19 Time: A Take on How not to Misapply the Quantity Theory of Money

The Covid-19 crisis has revived an old heated debate on whether significant increases in the money supply -such as the ones accompanying central banks' unconventional policies- ultimately lead to higher inflation. Some observers have alluded to the quantity theory of money for that purpose, sometimes in a misleading way in our view. Against this background, this paper seeks to clarify several aspects of the quantity theory of money and the so-called "monetarist" approach to it, useful to apply it fairly in the current world. First, we review and discuss the meaning of the velocity term in the quantity equation. We argue that it has no relevance as a behavioral concept: there is no such thing as a "desired velocity". Rather, income velocity should be seen as a reduced-form variable, obtained from a larger system of parameters and variables related to money demand, as the monetarist approach clearly puts it. Second, we clarify the practical relevance that the quantity theory approach can bear in the 21st century. We argue that although the quantity theory is unsuitable to explain conventional monetary policies, the mechanism on which it builds bears relevance in analyzing some recent unconventional monetary policies.