Effect on the Economy of Increasing or Decreasing the Money Supply
Market for money if interest rates are high ==> surplus of money ==> more money in circulation than we actually want to spend,we don't hold it in m1, we want to earn wealth so we buy bonds or put it in savings account. Bonds have fixed price when they mature. there is a relationship between price of bonds and interest rate.
increase in MS>surplus of money ==.> purchase of bonds ==> Bond prices goes up ==>interest rates go down> investment spending goes up> AD goes up> real GDP goes up> and prices go up. this is used to close a recessionary gap. Called Expansionary monetary policy.
Decrease in MS> interest rates go up> investment spending goes down> AD goes down> real GDP goes down> prices go down. This is used to close an expansionary gap. Called contractonary monetary policy.
Monetarists think that the velocity of money is constant so an increase in the money supply will increase nominal GDP. increase in the money supply x will increase nominal GDP by v *$x. if the economy is in full employment then both Q and V are constant. Doubling the money supply(M) leads to doubling the prices(inflation). For canada velocity of M2 is 1, Mi = 3(means every dollar is spent 3 times per year
Dr. Stephanie Powers, "Monetary Policy", Intro to Macroeconomics.(Lecture, Donald School of Business, Red Deer Alberta, Winter 2012)
Market for money
if interest rates are high ==> surplus of money ==> more money in circulation than we actually want to spend,we don't hold it in m1, we want to earn wealth so we buy bonds or put it in savings account. Bonds have fixed price when they mature. there is a relationship between price of bonds and interest rate.
increase in MS>surplus of money ==.> purchase of bonds ==> Bond prices goes up ==>interest rates go down> investment spending goes up> AD goes up> real GDP goes up> and prices go up. this is used to close a recessionary gap. Called Expansionary monetary policy.
Decrease in MS> interest rates go up> investment spending goes down> AD goes down> real GDP goes down> prices go down. This is used to close an expansionary gap. Called contractonary monetary policy.
Monetarists think that the velocity of money is constant so an increase in the money supply will increase nominal GDP. increase in the money supply x will increase nominal GDP by v *$x. if the economy is in full employment then both Q and V are constant. Doubling the money supply(M) leads to doubling the prices(inflation). For canada velocity of M2 is 1, Mi = 3(means every dollar is spent 3 times per year
Dr. Stephanie Powers, "Monetary Policy", Intro to Macroeconomics.(Lecture, Donald School of Business, Red Deer Alberta, Winter 2012)