Question

i. Suppose the government of a country wants to achieve long run growth and they are thinking they can do this by printing money. Is this an effective policy for growth?

ii. In country BETA, full-employment level of real GDP is increasing at a rate of 6% per period and the money supply is growing at a 8% rate. What will be the long-run inflation rate in this country, assuming constant velocity?

Answer 1

i) To achieve long run growth, printing more money will raise cash holdings of people and tends to raise willingness to pay for goods which raise aggregate demand in an economy. This would cause price to rise which will reduce real power of money, thus you would be able to buy less units of goods with same money. We can say that this would not a effective policy for growth.

ii) Growth of money supply (M) = 8%

Growth of real GDP (Y) = 6%

Velocity is constant.

As per quantity theory of money:

%change in money supply * %change in velocity of money = %change in price level * %change in real GDP

8% = %change in price level * 6%

%change in price level = 1.33%

Thus, long run inflation would be 1.33%