The currency standard in the United States is called “fiat” which basically mean

Question

The currency standard in the United States is called “fiat” which basically means that money has no security backing. In other words, our government has the ability to print as much money as they feel is necessary. What would happen to each of the following economic variables: M1, interest rates, inflation and wages, if the government increased the money supply by 20 percent per year? In general, what impact does increasing or decreasing the printing of money have on the economy (in your discussion, use the concepts of the demand and supply of money). Use the demand and supply graph to explain your answer.

Explanation / Answer

When the money supply increases, the M1 money supply also increase becasue as the money supply increase, the currency held by public and bank deposits also increase thus M1 increased. When the bank deposits increase or when the money supply increases, the interest rate falls, becasue banks have now more reserves to lend out. so it can lend out at low interest rate to encourage borrower and thus interest rate decrease. when the interest rate decreases, the aggregate demand in the economy rises, because borrowing increase, new business starts, which reduce unemployement and increase output and thus aggregate demand to rise and therefore, the inflation will also rise. and the wage also increases.

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