Question

Suppose that a plot of the values of M2 and nominal GDP for a given country over$40$ 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.

Short answer

The country's monetary authorities should affect the money supply through focusing primarily upon that money supply.

Step-by-step solution

Step 1. Define money supply.

The revenue is the total sum of money publicly owned in a nation at any particular point in time.

Step 2. Explanation

The speed of the M2 money supply is highly consistent as a result of this continuous relationship, and so consumer spending is very stable. In this situation, altering the money supply, rather than interest rates, would give a close link to aggregate spending and hence should be employed in monetary policy.