Chapter 32, Problem 2CYU

To determine

The long run effect of money supply on the interest rate.

Explanation of Solution

Long-term price consistency can only be achieved in tandem with a rise in money supply, which is compatible with increased output. In the near term, independent of the movement of actual output, a decrease in the velocity of money circulation may have an impact on the rise in demand for money. Nevertheless, inflationary pressures will worsen if the growth in the money supply continues to be unrelated to the movement of output. The central bank influences the demand for money both directly as well as indirectly via monetary policy actions. In particular, it influences the rise in interest rates, which causes a drop in the demand for money, by raising the discount rate and reserve requirement rate.