Answer to Question #145919 in Macroeconomics for bisha

Question

(a) Explain Friedman’s money demand function, and discuss its policy implications. (8 marks)
(b) If inflation is a monetary phenomenon, why do most governments keep feeding the inflation with an ever increasing money supply? Use the AD-SRAS-LRAS framework to explain your answer. (9 marks)
(c) Use Friedman’s Expectation Augmented Phillips Curve to analyze the short-run and long-run impacts of each of the following change on inflation and the unemployment rate: (look at gallery, got take photo)
(i) an once-and-for-all permanent rise in money supply; and
(ii) a permanent increase in monetary growth. (8 marks)

Answer 1

(a)

Demand for money is a function of the following parameters:

Dm = f (rs, rb, πe, W)

where rs is the estimated real earnings per share; rb is the expected real yield of the bond; πe is the expected inflation; W is total wealth.

The theory of monetarism, developed by the American economist, University of Chicago professor M. Friedman, an adherent of the free market idea, proposes to limit the role of the state only to activities that no one else can carry out: regulation of money in circulation. The rate is also placed on tax cuts. At the same time, according to the theory of monetarism, one of the main means of regulating the economy is to change the money supply and interest rates in the bank. Since the state every year increases its costs, entailing an additional increase in inflation, it should not be allowed to create wealth in society, regulate production, employment and prices. However, it can help regulate the money supply by removing excess money from circulation, if not through loans, then through taxes. Thus, the combination of tax cuts with manipulation of the money supply and the interest rate makes it possible to create the stability of the functioning of the mechanism of not only state but also private enterprises.

(b)

Inflation isn't necessarily a monetary phenomenon, it is only calculated as a monetary sense to establish a relative comparison. Inflation is more of a Supply and Demand Gap concept, where supply is relatively lesser than demand, the price thus commanded by the commodity goes higher.

Now, Inflation is also caused by many factors such as Fossil fuel prices in the international market, for the countries who are more relied on the West Asian Oil for their energy requirement.

Inflation is very healthy in an economy, as it encourages every factor in production for an higher incentive, from profits, wages, input cost, etc.

(c)Short-term Phillips curve

in a modified form, the Phillips curve was represented by the inverse relationship between price growth P and the unemployment rate U

The Phillips curve shows that there is a stable and predictable inverse relationship between unemployment and inflation. In the economy, there is a level of employment at which prices practically do not grow.

Long-term Phillips curve

In the long run the Phillips curve is completely inelastic to price changes when full employment is reached and becomes vertical.

currently, most economists recognize the traditional form of the Phillips curve in the short term and the almost complete absence of a relationship between inflation and unemployment in the long term.