Money Growth and Inflation

Why Increase in Money supply increase inflation

Money Exchange

  • Equation of Exchange: MV = PY

  • M = money supply

  • V = Velocity of Money

  • P = Price Level

  • Y = Real output

  • PY = nominal GDP

Conclusions'

  • In the long run, changes in price level are directly proportional to changes in money supply (M affects Y)

  • In the long run, changes in money supply have no effect on real variables (Real output, not nominal GDP. Remember Real is adjusted for inflation)

  • An increase in money supply has no effect on real output and employment

  • Quantity theory of money: The theory posits that the general price level of goods and services is directly proportional to the amount of money in circulation, encapsulated by the equation MV = PY, where M is the money supply, V is the velocity of money, P is the price level, and Y is the real output.

  • Inflation lead to no change in output in the long-run