Question

The US government and the Federal Reserve is a great source for economic data. The Federal Reserve site below will allow you to create graphs using data from the government.  Create a graph that includes a measure of money such as M1 or M2, consumer price index, unemployment rate and real gross domestic product over time. Put time on the horizontal axis of your graph and the other variables on the vertical axis. Use monthly data that covers a time period of at least five years, with 2018 as the most current year.  

Save your graph as a picture and answer the following questions.

According to your chart,

• Was the growth in GDP increasing or decreasing when unemployment increased?
• Was the growth in GDP increasing or decreasing when the consumer price index increased?
• When GDP was falling, was the money supply increasing or decreasing?
• When the consumer price index was increasing was the money supply increasing or decreasing?

Given your knowledge of economic theory, explain your findings from above.

research.stlouisfed.org/fred2/

Answer 1

1. As we can see from the chart, real GDP growth declines with an increase in unemployment. For instance between the last quarter of 2013 and first quarter of 2014, as unemployment rate increases, growth rate in real GDP slips below zero. As the economy employs lesser labor than before, production drops and that results in a contraction of total output.

2. As the graphs represent the levels and change in real GDP, change in consumer prices does not effect the growth rate of GDP adjusted for constant prices. Hence we cannot establish a relationship between real GDP growth and CPI.

3. According to the theory of monetary neutrality, money supply growth should not effect real variables such as real GDP and unemployment. This maybe a good approximation in the long run, but in the shorter run wages & prices tend to be sticky. They can get affected by changes in money supply and cause a change in the level of employment or output. Hence we cannot definitively establish a relationship between change in money supply and real GDP growth.

4. Movement in Money Supply is mirrored by Movement in CPI. From the Quantity theory of money we know that increase in money supply leads to an increase in price level and thus money supply growth is directly proportional to inflation.