1. You have learned that money velocity is rather stable. Assume for simplicity that the velocity is constant (the quantity theory of money). Explain how the growth in the money supply and inflation are related.
2. Have you noticed how the gas prices are down right now? That follows the decrease in the oil prices, and everyone seems to believe this decline in oil price is temporary. You attend a meeting at the Bank of Canada, and hear that their analyst suggests, "Low oil prices increase the aggregate demand, and we face a real possibility of an increased inflation. To prevent undesirable inflation, we must reduce the money supply." Using the IS-LM-FE model, analyze the analyst’s proposal, i.e., explain whether and why his proposal would prevent undesirable inflation.
3. Current situation: Amid the coronavirus epidemics, the Bank of Canada has made three interest rate cuts, one on a FAD, March 4, and then two “emergency” cuts on March 16 and March 27. Use the IS-LM-FE model to explain what the Bank is trying to achieve and why.
Sol 1 :
Money supply and inflation are related to each other in the following ways :
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