When would an increase in the money supply not result in a rise in inflation, according to a reader’s question?
- Inflation is caused by increasing the money supply faster than real output grows. Because there is more money pursuing the same quantity of commodities, this is the case. As a result, as monetary demand rises, enterprises raise their prices.
- Prices will remain constant if the money supply grows at the same rate as real output.
Simple example of money supply and inflation
- The output of widgets increased by 20% in 2001. The money supply is increased by 20%. As a result, the average widget price remains at 0.50. (zero inflation)
- In 2002, the output of widgets increased by 16.6%, and the money supply increased by 16.6%. Prices are unchanged, with a 0% inflation rate.
- In 2003, however, the output of widgets increased by 14%, while the money supply increased by 42%. There is an increase in nominal demand as the money supply grows faster than output. Firms raise prices in reaction to the increase in demand, resulting in inflation.
When the money supply expands, what happens?
An rise in the money supply often lowers interest rates, which stimulates spending by generating more investment and putting more money in the hands of consumers. Businesses respond by expanding production and ordering more raw materials. The need for labor rises as company activity rises. If the money supply or its growth rate lowers, the opposite can happen.
What effect does money velocity have on inflation?
When the velocity of money rises, the velocity of circulation rises as well, indicating that individual transactions are becoming more frequent. A higher velocity indicates that a given quantity of money is being used for several transactions. A high rate of inflation is indicated by a high velocity.
Does a bank robbery result in inflation?
Since Netflix recently released the first part of the fifth and final season of the popular Spanish TV series ‘Money Heist,’ the air has been filled with anticipation. The creators of the series have captivated an international audience with a nail-biting drama in which a criminal genius, dubbed “The Professor,” organizes a squad of misfit criminals to carry out a heist aimed at the Royal Mint of Spain and the Bank of Spain. The heisters, who are clothed in red jumpsuits and wearing Dali masks, want to print billions of Euros without stealing anything from the people. While the thieves survive on public sympathy and appear to be modern-day Robin Hoods (Brun, 2019), the play is essentially an economics lecture, since it introduces the audience to the notion of “liquidity injections,” among other things.
In layman’s terms, a liquidity injection is a step adopted by the central bank to expand the money supply in the economy by extending short-term loans to individuals or private businesses (Hamilton, 2007).
“In 2011, the European Central Bank (ECB) made 171 billion euros out of nothing185 billion in 2012; 145 billion euros in 2013,” the lecturer says in one instance (Brun, 2019). He goes on to say that, while the ECB calls it a “liquidity injection,” the money “came out of nowhere” and was, in fact, theft (Brun, 2019). Based on this understanding, the robbers are convinced that they are carrying out the bank’s instructions and directly pumping printed money into Spain’s economy. While even the most inexperienced economist realizes that printing too much money causes inflation, the heisters claim that this infusion will have no such effect. This is the exact point at when a conflict arises.
The heisters mint money at the Royal Mint of Spain in the first two seasons of ‘Money Heist.’ The ‘no inflation’ perspective in the first two seasons is perfectly explained by a basic comprehension of how the European Central Bank works. All bank-printed notes are required to be reported under ECB regulations (Brun, 2019). As a result, for true inflation to exist, the printed notes must be reported, which the robbers in the series fail to accomplish, resulting in no direct impact on the Spanish economy.
Furthermore, the professor is optimistic that the Spanish government would do everything possible to maintain the value of the Spanish paper money in order to avoid inflation. The Professor is shown ripping a 50 note in front of the robbers and exclaiming, “It’s nothingIt’s paper, you see!” in a memorable moment. “It’s only paper!” (2019, Brun) He is attempting to demonstrate to the robbers that paper money has no intrinsic value and is only based on people’s belief that they would be able to sell products of that value using the paper note.
On the other hand, it might be stated that while printing notes will have no immediate influence, the counterfeit notes will be tracked when robbers use them to make transactions. In that event, the illegitimate notes will enter Spain’s banking system and, as a result of the multiplier effect, indirectly cause inflation. In the case of inelastic products purchased by heisters with illicit funds, the price of the item will rise as the number of purchasers in the market increases. Indirectly causing inflation in the Spanish economy.
As a result, while the heisters will not cause inflation in the traditional sense in the series, their acts will result in the illegal conduct of the monetary system in Spain’s democracy.
The heisters, led by the infamous ‘Professor,’ target the Bank of Spain over the next three seasons in order to steal the country’s gold reserves. In keeping with their socialist revolution strategy from the first theft, the criminals plan to undermine Spain’s monetary system with their second heist. Today’s global monetary competition is dominated by gold. Many developed countries, such as Russia and China, use gold reserves to peg the value of their currencies to something other than the US dollar (Brun, 2019). Apart from its value, gold is extremely popular among citizens due to its diversification of money reserves. Because it is a low-volatility investment, it serves as a safe haven for investors all over the world.
If the robbers succeed in taking Spain’s gold reserves, the value of the currency would fall as the authorities will be forced to create additional paper notes in order to purchase gold from other countries. The system may also be unable to maintain stability during periods of inflation, as gold is utilized to keep the value of fiat money stable. When people anticipate rising inflation, they tend to buy more gold because it gives them a greater chance of dealing with the weak economy (Brun, 2019). As a result, plundering the gold reserves would aid the gang of heists in disrupting Spain’s monetary system.
Both heists are part of a series with the goal of having a significant impact on the Spanish economy. This demonstrates that the Professor is the best economics professor in the world! In short, the designers of ‘La Casa De Papel’ have built an economic masterpiece, examining every minute element of the Spanish economy and setting it out for the rest of the world to study and comprehend.
Shristi Sarawgi is a second-year Economics student at Indraprastha College for Women in Delhi.
What effect does supply and demand have on inflation?
The available supply shrinks as demand for a certain commodity or service grows. When there are fewer things available, people are ready to pay more for them, according to the supply and demand economic theory. As a result of demand-pull inflation, prices have risen.
Money supply can rise if
- Banks like to keep their liquidity ratios low. As a result, banks will be more ready to lend a larger amount of their capital.
- An influx of wealth from outside the country. If the Bank of England is required to purchase surplus pounds on the foreign exchange market in order to build up foreign reserves. This sterling will be used by foreigners to buy UK exporters, which will then be deposited in banks, resulting in the creation of credit, which will multiply the money supply. This will only happen if the B of E tries to keep the e.r below the equilibrium level.
- Because bank deposits are considered liquid assets, if the government sells securities to the B of E, the money supply will rise.
- If the er does not rise, the government will sell securities to foreign buyers, resulting in an increase in the MS.
- The Bank of England offers Treasury notes to the banking industry. These are considered liquid assets and can be used as a liquidity base for additional customer loans. As a result, the money supply will grow at a doubled rate.
- Bonds are sold by the government to the banking industry. Bonds are considered illiquid, and as a result, they will not be utilized as a basis for lending money.
- The government sells bonds or bills to non-banking financial institutions. If the public purchases something from the government, their bank deposits will be reduced, and the money supply will not expand.
- Fiscal policy that is expansionary. In a liquidity trap, lowering the liquidity ratio may not boost the money supply since banks and enterprises are unwilling to lend and borrow. There is sometimes a ‘paradox of thrift’ in the business world, with consumers wanting to increase their savings – which leads to a reduction in spending and investment. If the government borrows from the private sector and spends on public work investment programmes, a multiplier effect will occur, with families receiving wages to spend and private sector investment being encouraged.
Flow Of Funds Equation
- If we want to compare the size of the money stock at one point in time (Mst) to that at a prior point in time (Mst-1), we must look at the money flow (change) between these two points (change Ms)
- If the banking sector reduces its liquidity ratio in response to rising loan demand,
- If there is a surplus in currency flows and so a net influx from overseas. The portion of government borrowing that is funded by borrowing in foreign currency is also included in item four, which lessens the government borrowing’s expansionary effect.
The relationship between Money Supply and the rate of interest
Some monetary theories presume that money supply is completely unaffected by interest rates. Keynesian models, on the other hand, assume that:
- Higher credit demand will raise interest rates, making it more appealing for banks to extend credit.
- Depositors may be enticed to move money from sight to time accounts if interest rates are higher. The liquidity ratio can then be reduced by the banks.
What effect will high inflation have on the money supply in the economy?
Explanation: The cost of things is rising. 3. What happens to the supply of money in the economy when there is a lot of inflation? Explanation: Money supply expands.
What causes money velocity to increase?
- The availability of money as well as the velocity of money have an impact on aggregate demand.
- The average number of times an average dollar is used to buy goods and services per unit of time is the velocity of money.
- The price of all final goods and services provided by an economy is known as nominal GDP. Therefore:
- As a result, prices rise when the money supply’s product and velocity grow faster than actual GDP.
- Economists treat the velocity of money and real GDP as constants in their short-run models to simplify them. Therefore:
When the money supply is reduced, what happens?
The term “expansionary” or “contractionary” refers to monetary policy that is either expanding or contracting. Contractionary policy aims to slow down economic growth, whereas expansionary policy aims to speed it up. In the past, expansionary policy has been employed to try to address unemployment during a recession by decreasing interest rates in the hopes of luring businesses into expanding. This is accomplished by raising the available money supply in the economy.
The goal of expansionary policy is to increase aggregate demand. Aggregate demand is the sum of private consumption, investment, government spending, and imports, as you may recall. The first two elements are the focus of monetary policy. The central bank stimulates private expenditure by raising the amount of money in the economy. The interest rate is reduced as the money supply is increased, which encourages lending and investment. A rise in aggregate demand is the result of increased consumption and investment.
It’s critical for policymakers to make trustworthy pronouncements. If private agents (consumers and businesses) believe politicians are devoted to economic growth, they will expect future prices to be higher than they would otherwise be. The private agents will then make adjustments to their long-term goals, such as taking out loans to invest in their firm. However, if the agents feel the central bank’s efforts are only temporary, they will not change their behavior, reducing the impact of the expansionary policy.
The Basic Mechanics of Expansionary Monetary Policy
There are various ways for a central bank to implement an expansionary monetary policy. Open market operations are the most common way for a central bank to pursue an expansionary monetary policy. The central bank will frequently buy government bonds, putting downward pressure on interest rates. The purchases not only expand the money supply, but they also encourage investment by lowering interest rates.
It is easier for the banks and organizations that sold the central bank debt to make loans to their customers since they have more cash. As a result, loan interest rates are lower. Businesses are likely to use the money they’ve borrowed to expand their operations. As a result, more jobs are created to build the new buildings and staff the new positions.
Inflation is caused by an increase in the money supply, yet it is crucial to remember that different monetary policy tools have varying effects on the level of inflation in practice.
Other Methods of Enacting Expansionary Monetary Policy
Increased discount window lending is another option to implement an expansionary monetary policy. The discount window allows qualifying institutions to borrow money from the central bank for a short period of time to address temporary liquidity shortfalls caused by internal or external disruptions. Reducing the discount rate, which is charged at the discount window, can stimulate more discount window lending while also putting downward pressure on other interest rates. Interest rates are low, which encourages investment.