Answer to Question #289560 in Macroeconomics for REE

Question

a. Suppose the central bank increases the rate of growth of the money supply. What effect will this increase in money growth have on seignorage in:

(1) The short run; and

(2) The medium run? Explain.

b. What is meant by debt monetization? Explain your answer with appropriate graph of the IS-LM model.

Answer 1

1) Increases

2) It drops back to the original level due to adjustment of inflation rate

3) Debt monetization is where the government borrows money from the central bank to finance public spending in place of selling bonds to private investors or raising taxes. Through this, new money is created in the process.

This can be illustrated by use of AD-AS model. If the government does this, the outcome is an increase in the monetary base which causes a shift of the aggregate-demand curve to the right leading to a rise in the price level as shown below.