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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

Both the portfolio choice and Keynes’s theories of the demand for money suggest that as the relative expected return on money falls, demand for it will fall. Why does the portfolio choice approach predict that money demand is affected by changes in interest rates? Why did Keynes think that money demand is affected by changes in interest rates?

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 “quarterly” using the frequency setting, and for all three series, use the “Percent Change from Year Ago” 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 “Percent Change from Year Ago” 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%?

Explain how the following events will affect the demand for money according to the portfolio theories of money demand:

a. The economy experiences a business cycle contraction

b. Brokerage fees decline, making bond transactions cheaper.

c. The stock market crashes. (Hint: Consider both the increase in stock price volatility following a market crash and the decrease in wealth of stockholders.)

Why might a central bank choose to monetize the debt, knowing that it could lead to higher inflation?
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