Question

According to the quantity theory of money, what would be the impact of expansionary monetary policy on real output and the price level?

Answer 1

The impact of expansionary monetary policy on real output and the price level would be:

• It leads to higher prices
• It leads to more potential output.
• The increase of money supply would lead to movement up along the aggregate supply curve.
• It leads to decrease in the value of money
• It causes inflation because of more money in the system.

Answer 2

The quantity theory of money affirms that the prices determination is directly related to the amount of money in circulation. Its equation says that the amount of money multiplied by its circulation speed is equal to the level of prices multiplied by the production. So, if an expansionary monetary policy is applied, then the amount of money will grow so the equation changes, the production grows as well so the prices level. This will happen in the short run affecting the output too which grows, known as the real effect.