Question

As the velocity of M1 began to fluctuate in the 1980s, having the money supply grow at a predetermined and unchanging rate seemed less desirable, because as the quantity theory of money shows, the combination of constant growth in the money supply and fluctuating velocity would cause nominal GDP to rise and fall in unpredictable ways. The jumpiness of velocity in the 1980s caused many central banks to focus less on the rate at which the quantity of money in the economy was increasing, and instead to set monetary policy by reacting to whether the economy was experiencing or in danger of higher inflation or unemployment.

(True/False)

Answer 1

The statement provided is true as fluctuations in the velocity of M1 during the 1980s led central banks to switch from a fixed money supply growth policy to one based on economic indicators like inflation and unemployment to manage the economy effectively.

Step-by-step explanation:

The statement you provided is true. The velocity of M1 refers to the rate at which money circulates within the economy. During the 1980s, the velocity of M1 began to fluctuate, making the approach of keeping the money supply growth constant less preferable.

According to the quantity theory of money, which posits that there is a direct relationship between the money supply and nominal GDP, a constant growth rate in the money supply combined with a fluctuating velocity would lead to unpredictable changes in nominal GDP.

In response to the unpredictable nature of velocity, many central banks shifted their approach. Instead of focusing solely on controlling the growth of the money supply, the central banks began to set monetary policy by addressing current economic indicators such as inflation and unemployment.

Their goals became more about maintaining economic stability, rather than trying to adhere to a predetermined growth rate in the money supply.

This adaptive approach allowed central banks to respond more effectively to changes in economic conditions and manage monetary policy in a way that aims to curb the risks of higher inflation or unemployment, thus contributing to overall economic stability.