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Money Growth and Inflation - Chapter 11.docx

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University of Ottawa
Serge Nadeau

Money Growth and Inflation The Classical Theory of Inflation • Inflation is more about the value of money than the value of goods • Value of money is the reciprocal of price level Money supply, demand and equilibrium - Money supply is determined by the Bank of Canada and the banking system - Demand reflects the wealth that people want to hold in liquid form which depends on reliance on credit cards, interest rate and price level - In the long run, the prices adjust to level at which supply = demand The Effects of a Monetary Injection - An increase in the money supply decreases the value of money and increases the price level - The immediate effect of a monetary injection is an excess supply of money but people will try and reduce their holding by buying goods/services or making loans, which will increase the demand for goods and services (however supply does not change) and thus prices will increasing moving the supply and demand into their new equilibrium • Classical Dichotomy is the theoretical separation of real and nominal variables • Monetary neutrality is the proposition that changes in the money supply do not affect real variables in the long run (I.e changing the length of a metre) • Velocity of money is the rate at which money changes hands V = (P x Y) / M V=Velocity , M= money supply, Y= real GDP, P= Price level M x V = P x Y Quantity equation 1) Velocity of Money is relatively stable over time 2) So then, a change in M results in a
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