According to monetarists, changes in velocity can
a. lower GDP or raise GDP.
b. raise GDP, but not lower GDP.
c. lower GDP, but not raise GDP.
d. shift the SRAS, but not the LRAS
The correct answer and explanation is:
The correct answer is: a. lower GDP or raise GDP.
Monetarists argue that the relationship between money supply, velocity, and economic output is central to understanding changes in GDP. According to monetarist theory, GDP is determined by the total supply of money in the economy and its velocity, which refers to the speed at which money circulates. Monetarists believe that changes in the money supply affect the overall economy through their impact on the velocity of money.
In this framework, the equation of exchange is crucial:
MV = PQ
Where:
- M is the money supply
- V is the velocity of money
- P is the price level
- Q is the quantity of goods and services (real GDP)
If the velocity of money (V) increases, the same amount of money supply (M) can support a higher level of output (Q) without increasing the money supply. This would raise GDP. Conversely, if the velocity of money decreases, even with a constant money supply, the economy might experience lower output (Q), resulting in a lower GDP.
In essence, changes in the velocity of money can lead to both an increase or a decrease in GDP, depending on whether the velocity is rising or falling. Monetarists emphasize the importance of controlling the money supply and recognize that fluctuations in velocity can have significant effects on economic performance, making the relationship complex and bidirectional.
Monetarists also argue that velocity is relatively stable in the short run, but it can change due to factors such as changes in consumer confidence, interest rates, or expectations about future inflation. Therefore, they believe that policy actions which influence money supply and velocity can directly impact GDP, both raising and lowering it depending on the direction of these changes.