For a given money demand, an increase in money supply will lead to an excess supply of money and thus the interest rate will fall. Note that according to this view, the interest rate and money supply move in the opposite direction. Graphically, in the real supply and demand, and the IS-LM settings, the above case can be illustrated as (2) Inflation Expectations Effect: LR and flexible P Fisher’s equation says i = r + ; and i = r + in the long-run, The nominal interest rate is equal to the real interest rate, which is independent of monetary variables, and the expected rate of inflation. If any change in money supply increases the expected rate of inflation (), or the long-run actual rate of inflation (), then there will be a change in the interest rate. The implications are as follows: Government can control only the nominal interest rate, not the real interest rate. The net impact of an increase in money supply on the nominal interest rate is the sum of liquidity and expectations’ effects. The natural question is what kind of increase in the money supply would lead to an increase in the expected or actual rate of inflation. For example, a truly once-and-for-all blip of increase in money supply does not change the expected or long-run rate of inflation. So only the liquidity effect works. 2) Three Different Kinds of Money Supply, and their impacts on Inflation and Interest Rate Real money (cash) demand has direct bearing on the social welfare. The change in real money demand is important. Real money demand is the ratio of nominal money supply to the price level. Therefore the relative movements or a relative change of the money supply and the price level determines the size of real money demand. In this analysis, we would like to see whether an increase in the money supply would be accompanied with constancy of real money demand (M/P), or with a decrease in real money demand [(M/P) ↓]. In the case, the price level increase in the same proportion as the money supply so M/P does not change. This can only happen when there is no change in nominal interest rate which determines the real money demand.
For a given money demand, an increase in money supply will lead to an excess supply of money and thus the interest rate will fall. Note that according to this view, the interest rate and money supply move in the opposite direction. Graphically, in the real supply and demand, and the IS-LM settings, the above case can be illustrated as (2) Inflation Expectations Effect: LR and flexible P Fisher’s equation says i = r + ; and i = r + in the long-run, The nominal interest rate is equal to the real interest rate, which is independent of monetary variables, and the expected rate of inflation. If any change in money supply increases the expected rate of inflation (), or the long-run actual rate of inflation (), then there will be a change in the interest rate. The implications are as follows: Government can control only the nominal interest rate, not the real interest rate. The net impact of an increase in money supply on the nominal interest rate is the sum of liquidity and expectations’ effects. The natural question is what kind of increase in the money supply would lead to an increase in the expected or actual rate of inflation. For example, a truly once-and-for-all blip of increase in money supply does not change the expected or long-run rate of inflation. So only the liquidity effect works. 2) Three Different Kinds of Money Supply, and their impacts on Inflation and Interest Rate Real money (cash) demand has direct bearing on the social welfare. The change in real money demand is important. Real money demand is the ratio of nominal money supply to the price level. Therefore the relative movements or a relative change of the money supply and the price level determines the size of real money demand. In this analysis, we would like to see whether an increase in the money supply would be accompanied with constancy of real money demand (M/P), or with a decrease in real money demand [(M/P) ↓]. In the case, the price level increase in the same proportion as the money supply so M/P does not change. This can only happen when there is no change in nominal interest rate which determines the real money demand.
Monetarists%20and%20the%20Quantity%20Equation%20of%20Exchange.docx