The phrase ‘Equation of Exchange’ might sound like economic jargon, but it’s a concept with real-world bite. In 2025, as Australia navigates a patchwork of inflation pressures, digital payment surges, and shifting RBA policies, understanding this equation can help both policymakers and everyday Aussies make sense of the economic weather. So, what is the Equation of Exchange, and how does it shape the way money flows through our economy?
What Is the Equation of Exchange?
At its core, the Equation of Exchange is an identity linking the total money supply to how often money is spent and the value of goods and services in the economy. The classic formula is:
- M × V = P × Q
Where:
- M = Money supply
- V = Velocity of money (how often each dollar is spent per year)
- P = Price level
- Q = Quantity of real goods and services produced (real GDP)
This equation forms the backbone of the ‘quantity theory of money’—the idea that changes in money supply directly affect prices when the velocity and output are steady. In practice, though, velocity and output can shift, especially in turbulent times.
How the Equation Plays Out in 2025 Australia
Recent years have reminded Australians that inflation is not just a distant memory. The RBA’s rapid rate rises in 2023-24 were aimed at cooling spending and taming price growth. But the Equation of Exchange gives us a framework for understanding why those policy levers matter.
- Digital Payments & Velocity: The shift to contactless and real-time payments (like PayID and Osko) has changed how quickly money circulates. In 2025, the velocity of money has rebounded from pandemic lows, but not to pre-2020 levels. This affects how changes in money supply ripple through the economy.
- Money Supply Growth: During the pandemic, M1 and M3 measures of money supply ballooned as the government and RBA injected liquidity. In 2025, with quantitative tightening underway, the growth of money supply has slowed. This shift helps explain why inflation is easing, even as consumer demand stays resilient.
- Output and Supply Chains: Australia’s economic output has recovered, but supply chain shocks—such as those from climate events or global tensions—still threaten to reduce Q, pushing up P if M or V don’t adjust.
For example, if the money supply (M) grows faster than the production of goods and services (Q), and if people are spending money more quickly (V), it’s a recipe for higher prices (P)—aka inflation. The RBA’s policy challenge is to keep these factors in balance as the economy evolves.
Real-World Implications: From Mortgage Rates to Superannuation
The Equation of Exchange isn’t just for economists. Here’s how its moving parts affect Australians in 2025:
- Homeowners: As the RBA raises or lowers rates to influence money supply and demand, mortgage rates follow. If inflation (P) threatens to spike, expect higher repayments as the RBA tightens the taps.
- Consumers: If the velocity of money rises (think: everyone spending their pay sooner thanks to digital wallets), retailers may see faster sales growth—but if supply can’t keep up, prices will rise.
- Investors & Super Funds: Inflation eats into real returns. Understanding what’s driving P, Q, and M helps superannuation members and fund managers make smarter asset allocations.
- Policy Watch: The 2025 Federal Budget includes new reporting on digital currency flows, aiming to better track V as e-money becomes mainstream. This data will feed into RBA forecasts and, ultimately, the rates Australians pay on loans and earn on deposits.
Can the Equation Still Guide Policy?
Some critics say the Equation of Exchange is too simplistic for today’s complex, globalised economy. But as Australia’s policy debates focus on inflation targeting, wage growth, and productivity, the equation remains a vital tool for seeing the big picture. It reminds us that money, spending, and real economic activity are always in delicate balance. Policymakers may tweak the formula, but the underlying relationships endure—even as technology and consumer habits evolve.
Conclusion: Why the Equation of Exchange Still Matters
In 2025, the Equation of Exchange remains a powerful lens for decoding Australia’s economic story. Whether you’re watching RBA announcements, planning your household budget, or managing investments, understanding how money supply, velocity, and output interact is crucial. The more we grasp these dynamics, the better equipped we are to navigate whatever economic twists the future brings.
