Quiz 22: Money Growth and Inflation
Monetary neutrality: Classical economist believes that change in money supply effects merely nominal variables. Whereas, it influence the real variables in short run but in the long run. Hence, the option'd' is correct.
The given data can be summarized as follows: Money supply (M) = $ 500 billion Nominal GDP = $10 trillion Real GDP = $5 trillion Under this problem, all amounts are shown in billions. a) The Nominal GDP = P × Y = $10,000 and Y = real GDP = $5,000 Therefore, Since M × V = P × Y, Then b) If M and V are unchanged and Y rises by 5%, Then because M × V = P × Y , P must fall by 5%. As a result, nominal GDP remains unchanged. c) They keep the price level stable; the Fed must increase the money supply by 5%, comparing the increase in real GDP. Then, because velocity is unchanged, the price level will be stable. The money supply will be increase the level of price level. d) The Fed wants inflation to be 10%, it will need to increase the money supply by 15%. Thus M x V will rise 15%, Causing P x Y to rise 15%, With a 10% increase in prices and a 5% rise in real GDP.
From the quantity theory of money, an increase in the quantity of money causes a proportional decrease in the real value of money. From the graph, we could observe that when the Money supply is increased from MS 1 to MS 2 , the equilibrium shifts from 'a' to 'b' as the increase in the quantity of money reduces its demand. Thus the increase in the money supply from MS 1 to MS 2 decreases the value of money from .