Question

KPU Courses 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, MS 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$Vo = PYp: i. Carefully explain (1) The significance or meaning of each "side" of the Equation of Exchange: MSV, and PYp; and (2) How the expansion of Monetary Policy - or the growth rate in the Money Supply, MS could result in a higher rate of Inflation? (4 Marks)

Answer 1

m. Fried man always in the of more rapid money stated "Inflation is and everywhere a money tony phenomenon sense that it is produced only bej increase in the quantity than output" fischer version of equation of exchange Mgv=PT whore Ms = money supply v z velo city of mo money is P Aggregate price level in the learomy T = Total nö of transactions made in the economy. T is difficult to measure, To overcome use the national income. (y) this difficulty, wee . in the place of 'T' from of fisher version of equation Simple Where, и Msw=PY, Ms = money supply velocity of money p = Aggregate price level Yp= Aggregate output PYp= Nominal GDP of the economy

Equation of fine.hange, is MENO PYP In short bun velocity of money (wo) is fixed Yp (output level of the economy) is very in the short but it fined in pun -the. the long run. supply - will. How, cerrtinal banks adopted expansion any money tany pality. Therefore, money will be (Ms) of the econo economy increased. This increased in monty supply in c.peare. "the price. dered when IN and 'y is fixed, in the economy, you e.ramples, initial im money supply = $1000 velocity of money (vo) = 5 is fixed The level of out output = 10000 units putting this values on equation of exchange ve. will get 1000 x 5 = P xivodo P = 0.5. How money supply has increased. 4 times initial leved when velocity of level is fixed, then and outpul money .400085 = Px 1000g POL from it's price level = 2

Suppose , 'W' is money wage rate of the This can be explained with the help aggregate demand curve from AD, to Adqa Long of diogram. Due to the expansionany moneytany policy. shift will the aggregate supply curve. At point 'Ei output and price level both have increased, worker which is fined in the short run, p is the proico levele u - Real woge rate. 94RAS 7.52 P3 S, Price level, IN De Raal Gior Increased in money supply will increase the price level. Increased in price level will reduce the real croge rate. frims more labor as real wage rate has de.creased will employ

will Then output level of the economy be increased in the short bun. rate. But after some time, the cooker will Realize that their meal wogen mate has decreased. Then, they' will stant to bargain to increase theire, heal woge Then increased in real woge mate will shift the curve to the left word (ASe) This new supply curre (As 2) euts the 'Aa at point 'Es where economy will come book his initial output price level (P3). supply with highen 1