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Liquidity Theory Of Money

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1. Quantity Theory Of Money DEFINITION of 'Quantity Theory Of Money '
An economic theory which proposes a positive relationship between changes in the money supply and the long-term price of goods. It states that increasing the amount of money in the economy will eventually lead to an equal percentage rise in the prices of products and services. The calculation behind the quantity theory of money is based upon Fisher Equation:

Calculated as:

Where:
M represents the money supply.
V represents the velocity of money.
P represents the average price level.
T represents the volume of transactions in the economy.

BREAKING DOWN 'Quantity Theory of Money '
This theory originated in the sixteenth century as European economists noticed higher levels of inflation associated with importing gold or silver from the Americas.

According to how the formula is derived, holding the transaction volume and velocity of money constant, any increases in the money supply will yield a proportional increase in the average price level.

2. Liquidity Preference Theory DEFINITION of 'Liquidity Preference Theory '
The idea that investors demand a premium for securities with longer maturities, which entail greater risk, because they would prefer to hold cash, which entails less risk. The more liquid an investment, the easier it is to sell quickly for its full value. Because interest rates are more volatile in the short term, the premium on short- versus medium-term securities will

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