Question

According to the quantity theory of money and the Fisher effect, if the central bank increases the rate of money growth, what will happen to the private saving, national saving, investment, the equilibrium real interest rate, and the equilibrium nominal interest rate?

Answer 1

The quantity theory and Fisher effect are long-run impacts when there is flexibility in prices. The quantity theory predicts that an increase in rate of money growth will increase inflation, which, via the Fisher effect, will increase the nominal interest rate. Since the real interest rate is determined by non-monetary factors such as time preference, and capital productivity thus it remains unaffected. It encourages investment which in turn, through multiplier increases the income. An increase in money supply leads to a fall in the value of money because an increase in money supply causes an increase in inflation thus discourages the savings