Question 1

Even though monetary policy is neutral in the short run, it may have profound real effects in the long run.

Accepted Answer

Monetary policy is typically considered neutral in the long run, meaning it does not have a permanent effect on real variables such as output or employment, but it can have significant short-term effects on these real variables.

Question 2

Inflation induces people to spend more resources maintaining lower money holdings. This is called shoe leather costs.

Accepted Answer

When inflation rises, people increase their spending to avoid keeping too much cash on hand, which reduces their purchasing power. This leads to increased transaction costs of time and effort spent on going to the bank for withdrawals or using other means to reduce their cash holdings, which is referred to as shoe leather costs.

Question 3

Suppose the Bank of Canada sells government bonds. Use a graph of the money market to show what this does to the value of money.

Accepted Answer

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Question 4

Economists agree that increases in the money supply growth rate increases inflation and that inflation is undesirable. So why have there been hyperinflations and how have they been ended?

Accepted Answer

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Question 5

In recent years, Bolivia, Russia, and Turkey have had much higher nominal interest rates than Canada, while Japan has had lower nominal interest rates. What would you predict is true about money growth in these other countries? Why?

Accepted Answer

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Question 6

What are the costs of inflation?

Accepted Answer

The answer of What are the costs of inflation?...

Question 7

In the long run, an increase in the growth rate of the money supply leads to an increase in the real interest rate but no change in the nominal interest rate.

Accepted Answer

According to the Fisher effect, an increase in the growth rate of the money supply causes an equal increase in the nominal interest rate, but with no effect on the real interest rate. This is because the increase in the money supply causes an increase in inflation expectations, which leads to a corresponding increase in nominal interest rates to compensate lenders for the expected loss in purchasing power. Therefore, both the nominal interest rate and inflation increase by the same amount, leaving the real interest rate unchanged.

Question 8

Prices are many times higher today than they were 30 years ago, yet people do not work a lot harder nor spend a lot less. How can this be?

Accepted Answer

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Question 9

What assumptions are necessary to argue that the quantity equation implies that increases in the money supply lead to proportional changes in the price level?

Accepted Answer

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Question 10

According to the classical dichotomy, what changes nominal variables? What changes real variables?

Accepted Answer

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Question 11

The quantity theory implies that if output and velocity are constant, then a 50 percent increase in the money supply would lead to less than a 50 percent increase in the price level.

Accepted Answer

According to the quantity theory of money, if output (real GDP) and velocity of money are constant, then a 50 percent increase in the money supply would lead directly to a 50 percent increase in the price level.

Question 12

Using separate graphs, demonstrate what happens to the money supply, money demand, the value of money, and the price level if:
a. the Bank of Canada increases the money supply.
b. people decide to demand less money at each value of money.

Accepted Answer

The answer of Using separate graphs, demonstrate what happens to...

Question 13

Inflation distorts savings because people pay taxes on their nominal rather than their real interest income.

Accepted Answer

Inflation reduces the purchasing power of money, thus eroding the real value of savings. When people earn interest income on their savings, they are taxed on the nominal interest income rather than the real interest income. As a result, inflation distorts savings and reduces the after-tax return on investment.

Question 14

Explain the adjustment process that creates a change in the price level when the money supply increases.

Accepted Answer

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Question 15

Define each of the symbols and explain the meaning of M × V = P × Y.

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Question 16

Suppose that velocity and output are constant and that the quantity theory and the Fisher effect both hold. What happens to inflation, real interest rates, and nominal interest rates when the money supply growth rate increases from 5 percent to 7 percent?

Accepted Answer

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Question 17

The source of all four classic hyperinflations was high rates of money growth.

Accepted Answer

All four classic hyperinflations (Germany in 1920s, Hungary in 1940s, Yugoslavia in 1990s, and Zimbabwe in 2000s) were caused by a high rate of money growth. When governments print excessive amounts of money, it reduces the value of the currency, leading to hyperinflation.

Question 18

If the Bank of Canada were to unexpectedly decrease the money supply, creditors would gain at the expense of debtors.

Accepted Answer

If the Bank of Canada were to decrease the money supply, there would be less money available in the economy, which would cause interest rates to rise. This would benefit creditors who would receive higher interest payments on loans they have given out. However, debtors would suffer as they would have to pay more interest on loans they have taken out. So, overall, creditors would gain at the expense of debtors.

Question 19

List and define any two of the costs of high inflation.

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Question 20

What is the inflation tax, and how might it explain the creation of inflation by a central bank?

Accepted Answer

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Quiz 11: Money Growth and Inflation