In economics, the velocity of money refers to a key term in the "quantity theory of money," which centers on the "equation of exchange":
where
The left-hand side of the equation above equals the total amount of money spent during the month. The right-hand side equals the amount of money received. This is comparable to saying that the amount of rain falling from the sky equals the amount hitting the ground--a statement that is true but useless. This is a major weakness of the quantity theory, and has led to a good deal of criticism.
Given this identity, the velocity of money can be measured as
In an early work espousing the quantity theory, velocity is defined as 'the ratio of net national product in current prices to the money stock.'Template:Fn
Historically, the main rival of the quantity theory has been the real bills doctrine, which says that the value of money is determined by the assets and liabilities of the money-issuing entity, rather than by the ratio of money to real GDP.
The equation of exchange can be used as a rudimentary theory of inflation. If the velocity of money is given by financial institutions (such as the role of bank accounts and credit cards) and the amount of production is always at a fixed level (say, at full employment), then any increase in the amount of money leads to rising prices for the economy as a whole, i.e., inflation.
If V and Q are constant, then we can state the equation of exchange in terms of rates of growth:
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