Why does this lead to a higher price level? I\'m confused can someone explain th

Question

Why does this lead to a higher price level? I'm confused can someone explain this.

This general money demand equation implies that the price level depends not only on todays money supply but also on the money supply expected in die future. To see why, suppose the fed announces that it will increase the money supply in the future, but it does not change the money supply today. This announcement causes people to expect higher money growth and higher inflation. Through the Fisher effect, this increase in expected inflation raises the nominal interest rate. The higher nominal interest rate increases the cost of holding money and therefore reduces the demand for real money balances. Because the Fed has not changed the quantity of money available today, the reduced demand for real money balances leads to a higher price level. Hence, expectations of higher money growth in the future lead to a higher price level today.

Explanation / Answer

If people have enough money in hand, their spending capacity increases. It causes inflation. Since the money supply will increase in future, it is expected that inflation would be there in future too.

It encourages consumers to purchase more today for avoiding purchase at inflationary price in future. Since resources are limited in the short-run, purchasing more creates more demand and increases price. Therefore, expectation of higher money growth in future leads to a higher price level today.

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