Question

In the context of the Quantity Theory of Money explain the relationship between changes in money supply and inflation. Why do you think this relationship should hold only in the long-run? Explain.

Answer 1

According to quantity theory of money, there is an equal percentage change in money supply And change in inflation

Because according to quantity theory of money, MV=PY

Velocity is assumed to be constant and Y is potential output which is equal to full employment output. However economy produces at full employment output only in long run leading constant value for real Income

Thus %change in money supply+change in velocity=%change in price+%change in Y(real GDP)

In long run %change in Y=%change in Velocity=0