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Chapter 25: Problem 6

During the years from 2010 to 2016 , the average annual growth rate of \(\mathrm{M} 1\) was 10.3 percent, while the inflation rate as measured by the GDP deflator averaged 1.6 percent. Are these values consistent with the quantity equation? If you would need additional information to answer, state what the information is. Are the values consistent with the quantity theory of money? Briefly explain.

Short Answer

Expert verified
No, the given values are not consistent with the quantity equation assuming that the velocity of money and real output are constant. You would need information about the velocity of money and the real output to definitively answer the question.

Step by step solution

01

Understanding the inflation rate

The inflation rate is measured by the percentage change in the GDP deflator. The information given in the problem states that the inflation rate averaged 1.6 percent. Based on the quantity theory of money, this should be approximately equal to the growth rate of the money supply if we assume that the output (Y) and the velocity of money (V) remain constant.
02

Comparing the inflation rate and the growth of money supply

The problem states that the average annual growth rate of money supply (\(\mathrm{M} 1\)) was 10.3 percent. This is significantly different from the inflation rate of 1.6 percent. Therefore, if the velocity of money and the real output were constant, these values would not be consistent with the quantity equation.
03

Establishing the missing information

In order to definitively answer the question, you would need additional information about the velocity of money and the real output. If either or both of these were changing during the years from 2010 to 2016, it could explain the discrepancy between the inflation rate and the growth rate of the money supply.

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Most popular questions from this chapter

In the late \(1940 \mathrm{~s}\), the communists under Mao Zedong were defeating the government of China in a civil war. The paper currency issued by the Chinese government was losing much of its value, and most businesses refused to accept it. At the same time, there was a paper shortage in Japan. During those years, Japan was still under military occupation by the United States, following its defeat in World War II. Some of the U.S. troops in Japan realized that they could use dollars to buy up vast amounts of paper currency in China, ship it to Japan to be recycled into paper, and make a substantial profit. Under these circumstances, was the Chinese paper currency a commodity money or a fiat money? Briefly explain.

(Related to the Apply the Concept on page 890) During the German hyperinflation of the \(1920 \mathrm{~s}\), many households and firms in Germany were hurt economically. Do you think any groups in Germany benefited from the hyperinflation? Briefly explain.

What is the main difference between the \(\mathrm{M} 1\) and \(\mathrm{M} 2\) definitions of the money supply? Why does the Federal Reserve use two definitions of the money supply rather than one?

Suppose that Congress passes a new law that requires all firms to accept paper currency in exchange for whatever they are selling. Briefly discuss who would gain and who would lose from this legislation.

Why did Congress decide to establish the Federal Reserve System in \(1913 ?\)
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