Unit 9: Money Growth and the Classical Dichotomy
Why printing money can never make a country richer, and the long-run separation between the real economy and the price level that follows from it.
5 topics · 18 questions
Each topic is a path, not a menu: work down it in order and every question builds on the one above. Click any of them to watch the answer draw itself.
The Quantity Equation: Money, Velocity, Prices, and Output
- How it worksHow does the equation M times V equals P times Y tie the money supply to the price level once velocity and output are known?
- Worked exampleFind velocity when the money supply is 4 trillion dollars, the price level index is 1, and nominal GDP is 24 trillion dollars.
- Common mistakeWhy isn't velocity a number that economists simply invented to make the quantity equation balance?
- Going furtherWhat happens to the quantity equation's prediction once velocity itself starts swinging around unpredictably?
- Ties togetherHow does the quantity equation reduce to the same MV equals PY expression used to size nominal GDP in an earlier unit?
Your turn1 of 2
Find velocity when the money supply is 5 trillion dollars, the price level index is 1, and nominal GDP is 26 trillion dollars.The Quantity Theory of Money
- How it worksHow does holding velocity and real output fixed turn the quantity equation into a straight-line prediction about inflation?
- Worked exampleFind the inflation rate predicted when the money supply grows 9 percent a year, velocity is stable, and real output grows 2 percent.
- Common mistakeWhy isn't having more money in an economy the same thing as having more goods in that economy?
Your turn1 of 2
Find the inflation rate predicted when the money supply grows 10 percent a year, velocity is stable, and real output grows 3 percent.The Classical Dichotomy and Monetary Neutrality
- How it worksHow does the classical dichotomy split real variables like output and employment away from nominal variables like the price level?
- Common mistakeWhy doesn't monetary neutrality mean that a change in the money supply has zero effect on anything at all?
- Going furtherWhat happens to the classical dichotomy's clean split once wages and prices are allowed to be sticky in the short run?
- Ties togetherHow does long-run monetary neutrality explain why the long-run aggregate supply curve never moves when the money supply does?
Your turn1 of 2
Monetary neutrality states that in the long run, a change in the money supply doesn't affect real variables like output and employment. Does a change in the money supply still move nominal variables like the price level?Money Growth and Hyperinflation
- How it worksWalk me through a government financing its spending by printing money until prices start doubling every few weeks.
- Going furtherWhat happens to a hyperinflation once everyone starts expecting prices to double again next month?
- Common mistakeWhy doesn't inflation mean that every single price in an economy rose by exactly the same percentage?
Your turn1 of 2
If a government's money supply grows 15 percent per month, using the rule of 70, how many months does it take for the money supply to double?Seigniorage: The Inflation Tax
- How it worksHow does printing new money to pay for spending act as a hidden tax on everyone already holding cash?
- Common mistakeWhy isn't seigniorage a free source of revenue with no cost to anyone in the economy?
- Going furtherWhat happens to the real value of seigniorage revenue once inflation gets so high that people stop holding cash at all?
Your turn1 of 2
A government finances 62 billion dollars of spending by printing new money. If real GDP is 1254 billion dollars, what percent of GDP does this seigniorage represent?