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17 November, 01:05

What type of relationship exists between the growth of the money supply and changes in the inflation rate?

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  1. 17 November, 01:39
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    Answer: A direct relationship

    Explanation: The link or relationship between money supply and inflation rate : In normal economic circumstances, if the money supply grows faster than real output it will cause inflation. In a depressed economy (liquidity trap) this correlation breaks down because of a fall in the velocity of circulation. This is why in a depressed economy Central Banks can increase the money supply without causing inflation. This occurred in the US between 2008-14

    However, when the economy recovers and velocity of circulation rises, increased money supply is likely to cause inflation.

    In other words, If you are Increasing the money supply faster than the growth in real output will cause inflation. The reason is that there is more money chasing the same number of goods. Therefore, the increase in monetary demand causes firms to put up prices.
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