Mostly summarized from Gregory Mankiw’s Principles of Economics, 5th Ed.
PART 10 Money and Prices in the Long Run
Chapter 30 of 36 Money Growth and Inflation
Section 7 of 31
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Figure 2 – An Increase in the Money Supply
When the Fed increases the supply of money, the money supply curve shifts right from MS1 to MS2
· the value of money, on the left axis
· the price level, on the right axis
· adjust to bring supply and demand back into balance
· the equilibrium moves from point A to point B
When an increase in the money supply makes dollars more plentiful
· the value of each dollar decreases
· the price level increases
Lower value of the dollar increases the price of goods and services = inflation.
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At first the economy is at equilibrium, Figure 2 point A.
Then, the Fed doubles the money supply by buying government bonds from the public (open-market operations).
Per Figure 2
· the money supply curve moves to the right from MS1 to MS2
· the equilibrium moves from point A to point B
As a result
· the value of money, shown on the left axis, decreases from 1/2 to 1/4
· the equilibrium price level, shown on the right axis, increases from 2 to 4
When the money supply is increased
· the result is an increase in the price level = inflation
· which makes each dollar less valuable
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This explanation of how the price level is determined and how it can change over time is called the quantity theory of money.
According to the quantity theory of money theory the quantity of money available in an economy determines the value of money.
Growth in the quantity of money is the primary cause of inflation.
As economist Milton Friedman said, "Inflation is always and everywhere a monetary phenomenon."
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monetary phenomenon
kinsen genshō
金銭現象
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