Question

Present an analysis that explains why the growth of the nation's money supply might well be responsible for both the inflation we have observed but also responsible for some of the increases in the nominal wage level we have observed.

Answer 1

Money supply is directly associated with rise in inflation rate. Inflation refers to the rise in price level which is sustained for longer period of time. Rise in money supply leads to rise in aggregate demand. Demand puts upwards pressure on price level if supply does not respond to it appropriately. Sometimes, rise in demand due to money supply, is partly reflected on output and partly on price. Thus, Money supply reduces interest rate and induces consumption which pulls up inflation rates.

Spike in inflation reduces real wage rate, thus workers class starts demanding hike in wage rate. Thus, eventually wage rate also rises due to rise in supply of money.