Money, Banking, and International Finance

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0. 981

1. 05 1. 01

1. 02

1 1

1



 









+ π e

+ π

k

d

f (10)

Rule for the competitiveness ratio is a k greater than one indicates a country’s export
industries are not competitive, while a k less than one means the country’s industries are
competitive internationally.

Quantity Theory of Money

We can use the Quantity Theory of Money to expand the Purchasing Power Parity Theory.
The Quantity Theory of money begins with Equation 11, and we define every term as:

 Demand for money equals MD.

 We denote the price level by P.

 A country's real income is Y, and economists measure real income by a country’s real

GDP. Moreover, P × Y represents a country’s nominal GDP.

 Unique term is the velocity of money, V.

ܯ஽∙ܸ=ܲ∙ܻ (11)

People's demand for money must equal the supply of money. We denote the supply of
money by MS and substitute it into the equation. Supply and demand for money must equal each
other because a central bank injects money into the economy that the public uses. Public cannot
use money that the central bank does not supply. The interest rate ensures the supply and
demand of money equal each other. Furthermore, we solve for the velocity of money, shown in
Equation 12.

MS

P Y

V=



(12)

For example, if the nominal GDP of the United States equals $15 trillion or P × Y, and the
money supply is $1 trillion, then the velocity of money equals 15. Consequently, each U.S.
dollar is circulated in the economy 15 times during the year.
We can substitute the Quantity Theory of Money into the Purchasing Power Parity
Equation, yielding Equation 13. Price level for the United States is in the numerator while the
price level for the Eurozone is in the denominator. Thus, the exchange rate equals U.S. dollars
per euro.