Answered: The Federal Reserve, the central bank…

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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Question

The Federal Reserve, the central bank of the United States, has an inflation target of 0.3% per month. According to the Quantity Theory of Money, by how much must the Federal Reserve grow the money stock in order to hit its inflation target?

The Federal Reserve must decrease the money stock by 0.3% per year.

The Federal Reserve must increase the money sock by 0.3% per year.

The Federal Reserve must decrease the money stock by 0.3% per month.

The Federal Reserve must increase the money stock by 0.3% per month.

Expert Solution

Step 1

The quantity theory of money suggests that the price level or inflation in the economy is directly related to the money growth which is the amount of money. If we want to increase inflation, the central bank must increase only growth and to decrease the inflation r price level, the central bank must decrease the money growth.

MV = PY

Money supply* Velocity = Price level* Output level or GDP

The V and Y remain constant and an increase in M leads to increase in the P. If the central bank has an inflation target of 0.3% per month, the money supply must increase by 0.3%per month.

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