Discuss the evidence from India regarding the applicability of quantity theory of money.

Discuss the evidence from India regarding the applicability of quantity theory of money. 

Ans. QTM claimed that higher money supply means higher rates of inflations. This theory assumes that velocity is approximately constant and the price level mimics the money stock adjusted for output growth. We can write is as Log Pt = log Mt – log Yt + log Vt Since v is assumed to be constant, if M is growing faster than Y, then there will be inflation. So, in practice this assumption of constant velocity must work for this theory to operate. In Indian situation, the assumption of constant velocity did not hold good. In India case, two move together sometimes and sometimes they do not. In the short run, the velocity has varied between 6-7% but it is reducing since eighties. The velocity for broad money is falling more severely. Since in Indian economy, two are to moving in same direction always, the growth rate of broad money is much faster than the growth of inflation in 30 out of 35 years. Second prediction is concerned with relation between inflation and rate of interest. But in India statistics show as follows: 

1. Inflation during the 1970s was above 15% and rose again in early1990s. But the pattern of short term rates of interest showed close association with it. 

2. However, long run rate of interest did not show much correlation. 

3. Nominal interest rates do show some association with rate of interest. However there is wide fluctuation in growth rates of inflation and interest rates.