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2. Suppose a central bank has increased its nation’s nominal money supply considerably for several years...

2. Suppose a central bank has increased its nation’s nominal money supply considerably for several years in a row but without any increase in inflation. Over that same time, suppose its economy has not grown. Given this information, explain why this monetary policy has not yielded any results. Use the AD/AS model to aid in your answer and assume the economy is in a long-run equilibrium as your starting point. A good approach would be to compare what is supposed to happen to AD when the Fed conducts expansionary monetary policy to this situation.

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Answer #1

Due to money neutrality the monetary policy does not yield any long run results meaning when the Fed injects more money the AS firm are able to predict that this will happen and they will adjust their prices in account for the new money in the economy. The economy will be back to its starting point because the price will increase proportionately to the new money supply. Initially the AD curve will shift to its right but there is no real increase in the country's real gdp as SRAC curve will shift to the left back to the LRAC point. There will be increase in inflation but no increase in real gdp. To have zero in increase in inflation the money supply is increased, the price levels need to decrease by the same amount which causes zero shift in either curve and no change to real gdp.

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