[ich]

You are basically right. That's what makes the job of the federal reserve bank so hard. They need to measure V and T, which you rightly point out is not easy, and then they need to adjust M to keep P stable. And as you further rightly point out they only control a small part of M, i.e. the amount of cash. It basically works by the Reserve Bank having a good guess at V and T and then adjusting the cash rate hoping that it will encourage banks to adjust their general loan rates accordingly and thus having a significant enough impact on M.

[duschang27]

But doesn't the federal reserve uses Consumer Price Index(CPI) to measure P. Looking at how CPI is measured, it doesn't seem like it has a strong correlation with M. Cost is directly related to M, but price is not. Under these circumstances, doesn't it encourage merchants to artificially up the sales price to maximize their profit, regardless of the cost?

[duschang27]

and if the fed tries to lower the value of dollars to counter act this, wouldn't it ultimately dilute the profit of those who maintained the lower price? Thus starting the vicious cycle of price hikes