monetarists believe that velocity changes in a predictable way

The first quarter could be described as an increase in the demand to hold money by the public. The rate of growth of money, adjusted for a predictable level of velocity… d. a and c e. a, b and c. ... Monetarists believe all inflations are one-shot inflations and Keynesians believe all inflations are continued inflations. The AD Curve in the Simple Quantity Theory of Money—MV stands for total expenditures in this theory. What are the assumptions and predictions of the simple quantity theory of money? One interpretation for the equation of exchange is that the money supply multiplied by velocity must equal the price level times Real GDP. 1. This is unlikely to occur. D. Monetarists believe that output can be at less than full employment output in the short run. 59 out of 61 people found this document helpful. Provide three interpretations for the equation of exchange. For these reasons, monetarists conclude that monetary policy cannot be used for demand management in the short run. 18. Borrowers will borrow more funds as the interest rate falls, so the demand for loanable funds is downward sloping. When the price level rises, the purchasing power of money falls and the demand for loanable funds rises. Traditional monetarists like Milton Friedman, Karl Brunner or Allan Meltzer never claimed that velocity was constant, but rather that the money demand… One-shot inflation occurs when there is a single increase in the price level without any subsequent increases. When the Fed increases reserves, the liquidity effect predicts that interest rates will fall. Monetarists believe that future values of GDP can be predicted if the money supply (M) and the velocity of money (V) can be known or predicted. The new short-run equilibrium is established at point 2, where AD2 intersects SRAS1.There is a fall in the price level from P1 to P2 and also a fall in the GDP from QN to Q1. The timing and magnitude of these effects determine the changes in the interest rate. C) changes in government spending and taxes cause the aggregate demand curve to shift. This is called the liquidity effect. E) only (a) and (b) of the above. Usually, the demand for loanable funds increases by more than the supply of loanable funds, so that when the Real GDP increases, the income effect predicts that interest rates will rise. The evidence supports the spirit (or essence) of the simple quantity theory of money. It is difficult to predict exactly what will happen to interest rates when the money supply changes because a change in the money supply affects the economy in many ways: changing the supply of loanable funds directly, changing Real GDP and therefore changing the demand for and supply of loanable funds, changing the expected inflation rate, and so on. The longer the lines, the higher the inflation rate. Some monetarists believe that the velocity’s unexpected behaviour in recent years has to do with problems of definition or measurement. M is a vertical line (see diagram 3 above). In monetarism, what will lead to an increase in aggregate demand? c. the SRAS curve is upward sloping. 6. Once the price level settles where people think it will, the expectations effect disappears. Second, a decline in the rate of inflation caused people to spend less, which thereby decreased velocity (V). I grew up as a Milton Friedman monetarist, and predicting the impact of faster or slower money growth depends on velocity remaining somewhat stable, or at least predictable. What a change in M does to P, however, is a matter of debate. Course Hero is not sponsored or endorsed by any college or university. The simple quantity theory of money equation states that MV = PQ, where Q equals Real GDP. The controversy centres on whether and how V and Q are affected by changes in the money supply (M). Does the simple quantity theory of money predict well? When the price level changes, a price-level effect and an expectations effect will occur. In the short run, changes in the money supply or velocity will affect the price level, real GDP, and the unemployment rate. The policy causes fluctuations in AD. D) all of the above. Use the equation of exchange to explain changes in the price level. Do you agree or disagree with this statement? Consider a nominal interest rate of 15 percent. c. the SRAS curve is horizontal. As jobs are scarce, in the next wage negotiation round, workers receive lower wages, shifting the SRAS curve right, as in panel (b). Monetarists believe that velocity of money is relatively stable and changes therein are highly predictable. It follows that the. In monetarism, an increase in the money supply or in velocity will lead to an increase in aggregate demand. Monetarists also recognise that the demand for money can shift unpredictably in the short run with changing expectations. When the expected inflation rate rises, the demand for loanable funds rises and the supply of loanable funds falls, causing interest rates to rise. Monetarists believe that a. velocity changes in a predictable way. B. Monetarists believe that the velocity of money is predictable. Explain why it is difficult to predict exactly what will happen to interest rates when the money supply changes. To this end, it increases the money supply. What does the real interest rate equal, given the following: (a) Nominal interest rate = 8 percent; expected inflation rate = 2 percent; (b) Nominal interest rate = 4 percent; expected inflation rate = -4 percent; (c) Nominal interest rate = 4 percent; expected inflation rate = 1 percent. One of the consequences of using price controls is that non-money rationing devices will be used - one of which is first-come-first-served, which results in long lines of people waiting to buy goods. When Real GDP rises, corporations will tend to issue more bonds, raising the demand for loanable funds. In the end, the effect on the interest rate due to a rise in the price level remains. Can you get rid of infaltion with price controls? List the changes in the money supply, velocity, and Real GDP that are deflationary. Changes in expected inflation affect both the supply and demand for loanable funds. As shown in Exhibit 4, some factor causes AD to shift to the right in panel (a), creating an inflationary gap and lowering unemployment below the natural unemployment rate. Borrowers increase their borrowing in anticipation of higher inflation and lenders lower their lending. If velocity is stable, the equation of exchange suggests there is a predictable relationship between … b. aggregate supply depends on the money supply and velocity. The expectations effect. It’s not the case . This of course is a caricature. In recent years, economists have argued about the true value of the real interest rate at any one time and over time. In the simple quantity theory of money, the AS curve is vertical. Yes. Use the simple quantity theory of money to predict the effect of a change in the money supply. A second interpretation is that the money supply multiplied by velocity must equal GDP. Monetarists believe that the objectives of monetary policy are best met by targeting the growth rate of the money supply. Suppose the money supply rises on Tuesday and by Thursday the interest rate has risen also. Velocity Changes in a Predictable Way—Monetarists do not hold velocity to be constant. B) Monetarists believe that the velocity of money is predictable. On the other hand, a supply shock (such as a crop failure) would shift the SRAS curve to the left, causing an increase in the price level. Monetarists believe that changes in the money supply are both a necessary and sufficient condition to cause inflation. According to the equation of exchange, MV ≡ PQ, where M stands for the supply of money, V stands for the velocity of money, P stands for the price level and Q stands for GDP. Faced with these higher prices, the consumer-laborers will demand higher wages from their employers, shifting the SRAS leftward, ceteris paribus, and raising the price level. Explain your answer. A decrease in the money supply or velocity, or an increase in Real GDP, is deflationary. As shown in Exhibit 5, some factor causes SRAS to shift left in panel (a), creating a recessionary gap and unemployment greater than the natural unemployment rate. 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. Monetarists believe that: a. velocity changes in a predictable way. One of the consequences of using price ceilings is that non-money rationing devices, such as first-come-first-served will be used. The result is that interest rates would rise with an increase in expected inflation (Exhibit 7e). The loanable funds market, or credit market, is shown in Exhibit 7a. The monetarists believe that the direction of causation is from left to right in the equation; that is, as the money supply increases with a constant and predictable V, ... the money supply. The economy is self regulating (prices and wages are flexible) Monetarists believe: the … In the above figure, a decrease in the money supply or velocity will shift the AD curve leftward from AD1 to AD2, causing the price level to fall from P1 to P2 while Real GDP falls from Q1 to Q2 in the short run. In the long run, high unemployment rates will drive down the wage rate, which will shift the AS curve rightward from AS1 to AS2, causing the price level to fall again from P2 to P3 while Real GDP will return to its original level. Explain how demand-induced, one-shot inflation may seem like supply-induced, one-shot inflation. Monetarists believe that: a. velocity changes in a predictable way. In order to cause continued inflation, the Federal Reserve would have to increase the money supply every year, which it is capable of doing. Why do you think there is so much disagreement over the true value of the real interest rate? Traditional monetarists used to consider money-velocity as rather stable and predictable. 144 Chapter 14 II.MONETARISM —Monetarists believe there is a strong relationship between changes in the money supply and inflation. In the above figure, an increase in the money supply or velocity will shift the AD curve rightward from AD1 to AD2, causing the price level to rise from P1 to P2 while Real GDP rises from Q1 to Q2 in the short run. According to Friedman, changes in government expenditures and taxes have no visible effect on the economy, and hence the multiplier is non-existent. Theoretically, it is easy to compute the real interest rate. The money supply, the loanable funds market and interest rates. This is illustrated in Exhibit 4. The equation of exchange is an identity that states that, From the Equation of Exchange to the Simple Quantity Theory of Money. Explain what happens to the price level when the money supply increases. If the Federal Reserve increased the money supply, this would cause an increase in aggregate demand and a one-shot increase in inflation to a higher price level. Explain why. Monetarism is a set of views based on the belief that the total amount of money in an economy is the primary determinant of economic growth. In a country with price controls, inflation is seen in the length of the lines. C. Monetarists believe that the economy will settle into long-run equilibrium at less than full employment output. Money and the supply of loans—The supply of loans rises as the money supply increases and reserves in banks increase. Graphically show how a change in the money supply leads to a change in the price level, but not to a change in real GDP. Explain your answer. The expectations of higher inflation caused by increases in the money supply can be established overnight, and therefore, interest rates may rise as soon as the money supply increases in anticipation of higher inflation. Stimulus spending adds to the money supply, but it creates a deficit adding to a country's sovereign debt. Simply speaking, M 1 and the gross national product are not what they used to be arid because velocity equals GNP divided by M 1 , changes in the numerator and denominator can make a big difference. 35) Monetarists believe that . (a) An increase in velocity will tend to increase the price level. Classical economists believed that changes in the money supply affect the pricelevel. In the following graph, the economy is initially in equilibrium where AD1 intersects SRAS1 at point1. Monetarists believe that the velocity of money is highly stable. Suppose the objective of the Fed is to increase Real GDP. Of course, we have all learned that velocity is a reflection of the demand for money. 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. For inflation to continue there would have to be crop failures every year without a reallocation of resources to farming to offset the decrease in supply. Things will not change. Monetarists believe (1) the economy is self-regulating; (2) changes in M and V can affect aggregate demand; and (3) changes in M and V will change P and Real GDP in the short run, but only prices in the long run. We could have a 10 percent real interest rate and a 5 percent expected inflation rate, or a 9 percent real interest rate and a 6 percent expected inflation rate, or a 4 percent real interest rate and an 11 percent expected inflation rate, and so on. If V is stable, it follows from the equation of exchange that there is a direct predictable relationship between money supply and nominal GNP. Starting with long-run equilibrium, use the monetarist model to explain changes in the price level and Real GDP in the short run and long run due to a decline in velocity. Graphically show the short run and long run effects of a decrease in the money supply or velocity. When the money supply increases, the AD curve shifts rightward and, in the short run, Real GDP increases. 2. Whether the nominal interest rate is higher, lower, or the same today as it was 30 days ago depends on what? A) the aggregate demand curve is downward-sloping. List the changes in the money supply, velocity, and Real GDP that are inflationary. 1. A) Monetarists believe that the velocity of money is highly stable. Graphically show the short run and long run effects of an increase in the money supply or velocity. Why or why not? Keynesian economists generally say that spending is the key to the economy, while monetarists say the amount of money in circulation is the greatest determining factor. Some monetarists believe that the velocity’s unexpected behaviour in recent years has to do with problems of definition or measurement. d. a and c e. a, b and c ANS: d 42. Monetarism is a set of views based on the belief that the total amount of money in an economy is the primary determinant of economic growth. A decrease in the money supply will shift the AD curve leftward from AD1 to AD3, causing the price level to fall from P1 to P3 while Real GDP remains constant. The AD curve will be affected equally in opposite directions by the two factors and remain where it started. So the net result is that the economy comes back to its initial position with the same price level, but in the interim we experienced inflation. (a) The real interest rate = 8% - 2% = 6%. An increase in the money supply or velocity, or a decrease in Real GDP, is inflationary. Suppose the money supply increased 30 days ago. From One-Shot Inflation to Continued Inflation—Continued increases in aggregate demand can turn one-shot inflation into continued inflation, as seen in Exhibit 6. According to the simple quantity of money, what will happen to Real GDP and the price level as the money supply rises? There also is nothing new about the instability and unpredictability of velocity in the short run. In the above figure, aggregate demand curve shifts rightward from AD1 to AD2, causing the price level to rise from P1 to P2 while Real GDP rises from Q1 to Q2 in the short run. Think of a robotic Fed, no humans to screw it up. According to Friedman, changes in government expenditures and taxes have no visible effect on the economy, and hence the multiplier is non-existent. b. aggregate supply depends on the money supply and velocity. real interest rate is __________ percent. According to the simple quantity theory of money, a change in the money supply will lead to strictly proportional changes in the price level. c. the SRAS curve is upward sloping. If the nominal interest rate is 8 percent and the expected inflation rate is 2 percent, what percentage does the real interest rate equal? Explain what happens to the supply of loans when the money supply increases. In the next round of wage negotiations, workers demand and receive higher wages, shifting the SRAS curve left, as in panel (b). Monetarist: A monetarist is an economist who holds the strong belief that the economy's performance is determined almost entirely by changes in the money supply. 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. Can the money supply support a GDP level greater than itself? They do not believe that velocity is constant, nor do they believe output is constant. Usually, the demand for loanable funds increases by more than the supply of loanable funds, so that the interest rate rises (Exhibit 7c). In the simple textbook version of monetarism V in MV=PY is often assumed to be constant. Explain what happens to Real GDP when the money supply increases. Hence, when the price-level increases, the price-level effect predicts that interest rates will rise. An increase in the money supply or velocity, or a decrease in Real GDP, is inflationary. GDP is equal to the money supply multiplied by velocity. The real interest rate. Further, interest rates might rise. That is. Monetarists believe that the objectives of monetary policy are best met by targeting the growth rate of the money supply. Some economists believe the real interest rate is relatively stable over time, so changes in the nominal interest rate are due to changes in the expected inflation rate; but other economists do not agree with this, at least not to the same degree. This will result in long lines of people waiting to buy goods. When the money supply increases, reserves in the banking system increase and banks can make more loans. 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). True Monetarists agree that following a broad money expansion there will be a similar expansion in #NGDP if velocity remains constant . The income effect is the change in the interest rate due to a change in Real GDP. In monetarism, how will each of the following affect the price level in the short run? Monetarists … The assumptions of the simple quantity theory of money are that velocity and output are constant. To a potential borrower, which would be more important ,the nominal interest rate or the real interest rate? B. 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). It is difficult to tell whether an increase in the price level has its origins in a change in aggregate demand or aggregate supply. Aggregate demand depends on the money supply and velocity 3. A.Monetarist Views —There are four positions held by monetarists that we need to understand: 1. Explain your answer. Example 1. Monetarists say that velocity, V, is stable, meaning that the factors altering velocity change gradually and predictably. 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. That will increase interest rates. 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