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If a country increases its money supply growth rate from 2% to 4% per year, all...

If a country increases its money supply growth rate from 2% to 4% per year, all else constant, what will be the impact on its inflation rate and exchange rate according to the monetary approach?

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Answer #1

According to the quantity theory of money : MV = PT

Where, M = Money supply ; V = velocity of circulation ; P = average price level ; T = volume of transaction

If a country increases it's Money supply growth rate by 2%, other things being equal, price level will increase by 2%. Inflation rate will go up. Also, increase in the money supply decreases interest rate. As a result, demand for domestic currency decreases. This will depreciate domestic currency, or in other words, exchange rate depreciates.

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