An increase in the money supply or velocity, or a decrease in Real GDP, is inflationary. Jennifer received on their savings account over the year? The surplus in the labor market will cause the SRAS curve to shift back to SRAS1 and long-run equilibrium will be re-established. D) Monetarists believe that output can be at less than full employment output in the short run. Can the money supply support a GDP level greater than itself? As long as velocity is greater than 1, GDP will be larger than the money supply. The interest rate will decline (Exhibit 7b). It follows that the. Continued increases in the money supply will turn one-shot inflation into continued inflation. The increase in money supply that causes aggregate demand curve to shift from AD 0 to AD 1 brings about rise in price level from P 0 to P 1, level of GDP remaining fixed at Y F.But the monetarists explain business cycles on the one hand by the changes in money supply and, on the other hand, by the short-run supply curve which is assumed to be sloping upward. This will result in long lines of people waiting to buy goods. Velocity Changes in a Predictable Way—Monetarists do not hold velocity to be constant. Fiscal policy is not effective unless there is a change in money supply. The result is that interest rates would rise with an increase in expected inflation (Exhibit 7e). Monetarists believe that a. velocity changes in a predictable way. c. Monetarists believe that the economy will settle into long-run equilibrium at less than full employment output. The lenders will lend more money as interest rates rise so the supply of loanable funds is upward sloping. When Real GDP rises, corporations will tend to issue more bonds, raising the demand for loanable funds. Despite Keynesian reservations, monetarists made the case for stable and predictable money demand and velocity (Smith 1988:8). Suppose the money supply increases, boosting aggregate demand and raising the prices that consumer-laborers must pay for goods and services, while the short-run aggregate supply curve remains unchanged. Money and the supply of loans—The supply of loans rises as the money supply increases and reserves in banks increase. The difference between the price-level effect and the expectations effect. Velocity changes in a predictable way but does not change very much from one period to the next 2. What happens to the interst rate as the money supply changes. According to Friedman, changes in government expenditures and taxes have no visible effect on the economy, and hence the multiplier is non-existent. What a change in M does to P, however, is a matter of debate. The SRAS curve is upward sloping 4. 3. Stimulus spending adds to the money supply, but it creates a deficit adding to a country's sovereign debt. 35) Monetarists believe that . Second, a decline in the rate of inflation caused people to spend less, which thereby decreased velocity (V). They do not believe that velocity is constant, nor do they believe output is constant. The new long-run equilibrium is now established at point 3 where AD2 curve intersects SRAS2. According to the simple quantity of money, what will happen to Real GDP and the price level as the money supply rises? That is. Their position was based on the equation of exchange and the simple quantity theory of money. Some monetarists believe that the velocity’s unexpected behaviour in recent years has to do with problems of definition or measurement. The equation of exchange is M × V ≡ P × Q. Velocity is the average number of times a dollar is spent to buy final goods and services in a year. From the perspective of supply side economics, supply siders agree with the Keynesians that macroeconomic instability can result from supply side shocks. If aggregate demand increases, the price level will be higher in the long run than it was originally. Changes in Real GDP affect both the demand for and supply of bonds. Therefore, the aggregate supply curve is vertical at some level of Real GDP. Changes in expected inflation affect both the supply and demand for loanable funds. In an attempt to offset inflation's effects, interest rates are adjusted for the expected rate of inflation, so that the actual interest rate paid (the nominal interest rate) is equal to the real interest rate plus the expected inflation rate. Explain your answer. To achieve that direct effect, though, the velocity of money must be predictable.­ In the 1970s velocity increased at a fairly constant rate and it appeared that the quantity theory of money was a good one (see chart). Use the simple quantity theory of money to predict the effect of a change in the money supply. This is called the liquidity effect. Provide three interpretations for the equation of exchange. Explain your answer. From the Equation of Exchange to the Simple Quantity Theory of Money The simple quantity theory of money is derived from the equation of exchange by assuming that velocity and real output are constant in the short run, and therefore predicts that any change in the money supply will bring about a strictly proportional change in the price level as shown in Exhibit 1. c. the SRAS curve is upward sloping. It would be guaranteed to fall if the only thing that an increase in the money supply did was to affect the supply of loanable funds. The policy causes fluctuations in AD. But numerous combinations of real interest rates and expected inflation rates will give us a 15 percent nominal interest rate. Monetarists believe that the objectives of monetary policy are best met by targeting the growth rate of the money supply. D. Monetarists believe that output can be at less than full employment output in the short run. Monetarists believe that changes in the money supply are both a necessary and sufficient condition to cause inflation. Monetarists also believe that changes in velocity are insufficient to offset changes in M, because they believe that velocity is relatively stable and predictable. This of course is a caricature. C) changes in government spending and taxes cause the aggregate demand curve to shift. In the long run, labor market shortages will increase the wage rate, which will shift the AS curve leftward from AS1 to AS2, causing the price level to rise again from P2 to P3 while Real GDP will return to its original level. When the price level rises, the purchasing power of money falls and the demand for loanable funds rises. Monetarists believe that we have come a long way from the view that money does not matter to the view that money matters a great deal and still to the view held by some that money alone matters. Given that the Nominal interest rate = Real interest rate + Expected inflation rate, it follows that the Real interest rate = Nominal interest rate - Expected inflation rate. According to Friedman, changes in government expenditures and taxes have no visible effect on the economy, and hence the multiplier is non-existent. Exhibit 3 explains some of the highlights of monetarism, showing the short run and long run effects of changes in the money supply and velocity. b. Monetarists believe that the velocity of money is predictable. In the simple quantity theory of money, the velocity of money and the Real GDP are assumed to be constant. 1. The money supply, the loanable funds market and interest rates. Traditional monetarists like Milton Friedman, Karl Brunner or Allan Meltzer never claimed that velocity was constant, but rather that the money demand… Explain what happens to Real GDP when the money supply increases. The monetarists argue that in the long run V is determined totally independently of the money supply (M). c. the SRAS curve is upward sloping. This is unlikely to occur. Explain what turns one-shot inflation into continued inflation. The liquidity effect is the change in the interest rate due to a change in the supply of loanable funds and occurs when the Fed increases reserves in the banking system, therefore increasing the supply of loanable funds. If the nominal interest rate is 8 percent and the expected inflation rate is 2 percent, what percentage does the real interest rate equal? Monetarists believe that (1) velocity changes in a predictable way; (2) aggregate demand depends on the money supply and velocity; (3) the SRAS is upward sloping; and (4) the economy is self-regulating. This of course is a caricature. a. velocity changes in a predictable way. We know that this 15 percent nominal interest rate is composed of the real interest rate and the expected inflation rate. 6. They do not believe that velocity is constant, nor do they believe output is constant. The assumptions of the simple quantity theory of money are that velocity and output are constant. Or the effects of the increase in the money supply could be felt as an increase in the price level, reducing the increase in Real GDP (although, in the short run, some change in Real GDP should occur). In monetarism, an increase in the money supply or in velocity will lead to an increase in aggregate demand. Explain why. This is illustrated in Exhibit 4. 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monetarists believe that velocity changes in a predictable way

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