Questions on Money Supply and Inflation

Readers Question: Does money printing/QE always lead to inflation and price increases?

No. Increasing the money supply does not necessarily cause inflation. In particular, we have seen a large increase in the monetary base (narrow money) that hasn’t led to an increase in the general price level.

If you look at link between money supply and inflation – you can see situation in US where increase in monetary base failed to cause inflation.

Readers Question: If the new money is not spent and sits in accounts, how does this lead to inflation?

That is the key issue. In a deep recession, banks don’t want to lend, therefore they tend to keep this extra money in their bank reserves. Therefore, the extra money creation has little impact on the overall price level because there is not an increase in bank lending.

If the economy was booming, then this extra money would be lent to consumers and firms. This would cause an increase in the money supply and most likely inflation.

Readers Question: If price drops and people are not willing to pay increased prices despite having more money, does this lead to inflation?

If prices increase, then this will be counted as inflation. If people don’t want to buy goods, this is another issue. Inflation measures the price of goods in shops.

Readers Question: Is inflation by definition price increase, or is it an increase in all money supply?

Inflation means a sustained increase in the general price level. See: Definition inflation. There can be an increase in the money supply without inflation. Often the link between money supply growth and inflation is weak. They are separate things.

The monetarist theory of Inflation states MV=PY – we also have to take into account the velocity of circulation.

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2 thoughts on “Questions on Money Supply and Inflation

  1. Country A and Country B are both rish in Agriculture.Country A’s currency is called the Yemen and Country B’s currency is called Zina.It costs Country A 10 yemen to produce and sell 10kg bag of corn.It cost Country B 10 Zina to produce and sell the same product. At present, the exchange rate between the ywo countries are 1 yemen = 1 Zina.
    Suppose that for the upcoming year, the inflation rate in country A is expected to be 20% and the inflation rate in country B, is 0%.

    a) Which Country is expected to be more productive in the upcoming year?
    Explain for me please

    b) Based on the given information only, and ceteris paribus, do you expect the Zina to appreciate or depreciate against the yemen in the upcoming year, please explain?

    C.Based on the given information only, and ceteris paribus, what do you expect the exchange rate to be between the two countries one year from now( if the entire economies were driven by the market of corn.

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