Question

Present an analysis where you examine the long term impact of an increase in the money supply. Use your analysis to explain why increases in the money supply may explain the observed changes in both product prices and nominal wage levels over time. Also, uses your analysis to explain (using words) what it means when macroeconomists say “money is neutral.”

Answer 1

A rise in money supply in the economy reduces the rate of interest because people have enough cash in their hands such that they do not need to borrow money from market which induces lenders and borrowers to reduce the rate of interest they charge to attract borrowers. In short run, it reduces the rate of interest, raise price level by raising aggregate demand and raise real GDP in short run.

In long run, government needs to reduce their spending and have to adopt contractionary fiscal policy to avoid price hike for a long run and keep economy at its potential level. Adopting this policy in long run will reduce the rate of interest and lower price level and take real GDP to its initial level.

Neutraily of money says that monetary policy have no impact on real wages such as real GDP, employment in long run but can change them in short run.