The quantity theory of money and quantitative easing

Abstract

The measures taken by central banks to mitigate the effects of the 'Great Recession' triggered by the 2007 subprime mortgage crises in the USA have led to a spectacular increase in the stock of money, but the following price inflation that is predicted by the quantity theory cannot be observed anywhere. Is inflation in the pipeline, inevitably to emerge soon or later, as the critics of 'monetary easing' keep claiming? Does the failure of inflation to materialise finally falsify the quantity theory? To answer this question, we first highlight the most important characteristics of the latest economic slump. Then, an empirical analysis drawing on data on 109 countries from 1991 to the present confirms that the theory still has predictive power. While the classical proportionality theorem does not hold, excess money growth is a significant predictor of inflation. At the same time, the effect, although positive, is now so low that the fears regarding inflation as a consequence of the recent monetary easing do not appear warranted.