5.3 Money Growth and Inflation

a. Explain (using graphs as appropriate) how inflation is a monetary phenomenon. b. Define the quantity theory of money. c. Calculate the money supply, velocity, the price level, and real output using the quantity theory of money.

• Inflation (deflation) results from increasing (decreasing) the money supply at too rapid of a rate for a sustained period of time.
• When the economy is at full employment, changes in the money supply have no effect on real output in the long run.
• In the long run, the growth rate of the money supply determines the growth rate of the price level (inflation rate) according to the quantity theory of money.
• Enduring understanding POL-3: There are long-run implications of monetary and fiscal policy.