Arkensland is a highly industrialized countr. Prices have been steadily increasi

Question

Arkensland is a highly industrialized countr. Prices have been steadily increasing over the last few years and inflation reached an all-time high of 8 % last year. Following this, the central bank came under pressure to reduce inflation to least 4 % in this year. With real GDP expected to grow at 2% this year, the finance minister suggested that the central bank should ensure that money supply growth in the current year is not more than 6%. However, inflation at the end of this year turned out to be higher than 4%, even though real GDP grew at 2% and money supply growth was restricted to 6%. Which of the following can most reasonably be inferred from the above information? A. The velocity of money increased this year. B. THere is a risk of hyperinflation in Arkensland. C. The growth of GDP in Arkensland has stagnated. D. The central bank of Arkensland must have sold bonds this year in order to reduce the money supply.

Explanation / Answer

The Arkensland reduces the supply of money by selling bonds. As banks buy up these bonds they have less money to lend. Since they have got less money to lend they increase the interest rate ie the cost of money. With the higher interest rate and less people and institutions borrow money or borrow less money. In additionally because of the higher interest rates more and more people and institutions deposit money in banks to profit off of the higher interest. In the very short term which means that businesses and people are spending less of their total money which slows down growth and if there is not a lot of spending by the buyers then prices do not rise as much. Inflation is an important function how fast do the prices of goods rise ergo by reducing the money supply and will also reduce inflation

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