# How does the Monetary base, Narrow money and Broad money affect inflation?

In a lot of countries (e.g. Hungary) the M0, M1, M2 and M3 all doubled, tripled or even quadrupled in the past 10 years. How does this directly affect inflation?

Since just because M2 doubles, it doesn't mean that the Hungarian Forint is worth the half of what it did before. What is the relation between money supplies and consumer price indexes?

The relationship between money supply and price level (inflation is just change in the price level) is as follows:

$$P=\frac{MV}{Y}$$

Where P the price level, M is the money supply, V velocity of money and Y is the real output.

So price level is increasing in money supply and velocity of money, but decreasing in real output.

If everything else would be held constant price level would actually grow at the same rate as money supply, but in real life of course ceteris paribus condition is not satisfied. Real output continuously changes either due to economic growth or due to the boom/bust cycle, seasonal effects etc. Velocity of money is often though to be more or less constant, but it can change as well and in fact at zero lower bound, in a liquidity trap, changes in velocity can often offset increase in money supply preventing inflation.

Also, the above monetary formula is bit of an simplification because in more complex models not just the actual changes in these quantities but also expectations of these changes matter.

• Thanks! And what does the money supply consists of with respect to the M0-M4? Or can you calculate the actual money supply with those numbers? – curiousTrader May 24 '20 at 23:17
• @curiousTrader M0-M4 are different ways of measuring money supply. M0-M1 are the ‘narrow money’ - coins, banknotes and equivalents that can be easily converted into cash. From and M2 and above you get ‘broad money’. M2 includes in addition also short term deposits in banks. M3 includes in addition also long term deposits. M4 includes in addition also commercial paper, T-bills etc. – 1muflon1 May 24 '20 at 23:25
• But how do you calculate the money supply in practice? – curiousTrader May 25 '20 at 11:36
• @curiousTrader not sure what you mean by that - for example M0 can be calculated by counting coins and banknotes at their face value. For example if there is 10 \$100 bills in the circulation then M0 would \$1000. – 1muflon1 May 25 '20 at 11:42