Question

For the past decade, central banks around the world have adopted very expansionary Monetary Policy in order to decrease the key policy rate of interest by increasing the growth in the domestic Money Supply, M^S in order to stimulate domestic economic activity. Some commentators have been concerned about such policy resulting in higher rates of Inflation in the future as a result of the ‘Quantity Theory of Money.’ Using the Equation of Exchange, M^SV₀ = PY_P:

(1) The significance or meaning of each “side” of the Equation of Exchange: M^SV₀ and PY_P; and (2) How the expansion of Monetary Policy – or the growth rate in the Money Supply, M^S could result in a higher rate of Inflation?

Answer 1

m. fried man in the sense that mone stated "Inflation is always and everywhere. a money tany phenomenon it is produced only bey rapid increase in the quantity of money than output" fischer version of equation o exchange Mgv=PT whore of is ms of mone velocity y = money supply money P = Aggregate price level in the economy T = Total no of transactions made in output the economy. T is difficult to measume, To overcome ure the national this difficulty, we (y) in the place of 'T' Simple from of fisher version of equation Where и Ms v=PY, Me: money supply vo velocity of money P - Aggregate price level output PYp = Nominal GDP of Yp= Aggregate the economy

***** LRASI SR AS 2 SR ASI P₃ P2 Pricelevel K Pi 0 Y, YL Read GDP. by © Increased in money supply, will induce the consumme to to buy more gools and services, this shifts ad to the right from AD, to AD, it) firms will be respond increasing output along Shas. Deal output increases from Y, toyq. iii) National output now exceeds the equili briumdered of output. is an inttation many gop. firms will hire more. workers, therefore, wage willeincreased and Increased in woge will leads to increase. the cost and hence prices. so there 7

to work see an more But pealise the increase in nominal o Initially, workers ognee hours because they increase in nominal woge Aften some time on is not they can not pealized that real wage rate has decreased. periods, wookers V . Real wage increases. Then worke. will demand higher nominal wage to produce produce more more output. Therefon SRAs will shif to the left. The economy vii has returned to the equilibrium levede of output (Y,I withe higher price level Pa. So rise in money supply will rise AD (Aggregate demand). As L RAs it in elastie there is no increase in real output but inftation nises. It is a from of demand pulle inflation.