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Chapter 20: Q 2. (page 546)

If velocity and aggregate output are reasonably constant (as the classical economists believed), what will happen to the price level when the money supply increases from \(1trillion to \)4trillion?

Short Answer

Expert verified

The price level will rise fourfold in proportion.

Step by step solution

01

Step 1. Define money supply.

The price level will rise fourfold in proportion to the increase in the money supply.

The money supply is the entire value of all currency (coins & paper currency) issued by the Central Bank of India relative to the amount withheld by it.

02

Step 2. Explanation

The money supply is the entire value of all currency (coins & paper currency) issued by the Central Bank of India relative to the amount withheld by it.

The price level will rise fourfold in proportion to the increase in the money supply.

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Most popular questions from this chapter

Go to the St. Louis Federal Reserve FRED database, and find data on the M1 Money Stock (M1SL), M1 Money Velocity (M1V), and Real GDP (GDPC1). Convert the M1SL data series to 鈥渜uarterly鈥� using the frequency setting, and for all three series, use the 鈥淧ercent Change from Year Ago鈥� setting for units.

a. Calculate the average percentage change in real GDP, the M1 money stock, and velocity since 2000:Q1.

b. Based on your answer to part (a), calculate the average inflation rate since 2000 as predicted by the quantity theory of money.

c. Next, find the data on the GDP deflator price index (GDPDEF), download the data using the 鈥淧ercent Change from Year Ago鈥� setting, and calculate the average inflation rate since 2000:Q1. Comment on the value relative to your answer in part (b).

What happens to nominal GDP if the money supply grows by 17% but velocity declines by 24%?

Suppose a given country experienced low and stable inflation rates for quite some time, but then inflation picked up and over the past decade had been relatively high and quite unpredictable. Explain how this new inflationary environment would affect the demand for money according to portfolio theories of money demand. What would happen if the government decided to issue inflation-protected securities?

Suppose that a plot of the values of M2 and nominal GDP for a given country over40 years shows that these two variables are very closely related. In particular, a plot of their ratio (nominal GDP/M2) yields very stable and easy-to-predict values. On the basis of this evidence, would you recommend that the monetary authorities of this country conduct monetary policy by focusing mostly on the money supply rather than on setting interest rates? Explain.

鈥淧ersistent budget deficits always lead to higher inflation.鈥� Is this statement true, false, or uncertain? Explain your answer
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