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True or False? Explain why in one paragraph: The past value of M1 and M2 indicates...

True or False? Explain why in one paragraph:

The past value of M1 and M2 indicates that using only one monetary aggregate to guide policy is sufficient, since they both move together closely.

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Answer #1

The statement is false. Though it is true that both of these are monetray aggregates and M2 is greater than other, historical trend indicates that

  • Between 1960 and 1985, both of them grew at different rate but move together
  • Pattern has changed since 1985 where M1 grew more rapidly than M2,
  • During 1996-97 M1 fell so that its growth rate was negative and lower than that of M2

Morever, M2 gives a broader view of the economy as it already contains M1. The divergence between the two aggregates has increased over the years so it is not appropriate to consider one of them as a substitute for the other in analysing the economcic environment.

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