Reading: AB, chapter 7, section 4.

Inflation Rate Money Supply
Inflation Rate Real Gdp Money Supply Calculator
Inflation Rate Real Gdp Money Supply Equation
Nominal Gdp Real Gdp Inflation
Real Gdp Calculator

May 03, 2020 Real GDP–also referred to as “constant-price,” “inflation-corrected” or “constant-dollar GDP–is an inflation-adjusted measure of a country’s GDP. Real GDP does not have as clear of a relationship with the money supply. Real GDP tends to be more influenced by the productivity of economic agents and businesses. Impact of money supply, inflation, and interest rate on economic growth in Nigeria using the time series data from 1973-2013. They used VAR Model and Granger Causality Test to reveal the positive impact of broad money supply, while inflation and interest rate has a negative impact on growth in the long-run.

Recall, inflation is simply the growth rate of some aggregate price index like the CPI or the GDP deflator. If P(t) denotes the aggregate price level in year t then, symbolically, annual inflation from year t-1 to year t is given as: = %P(t) = (P(t) - P(t-1))/P(t-1).

We build a link between money growth and inflation through our model of money market equilibrium. In money market equilibrium, real money supply is equal to real money demand: M/P = L^d(Y, i). If we assume that the aggregate price level is free to adjust to keep the money market in equilibrium then we can use the money market equilibrium condition to solve for the aggregate price level: P = M/L^d(Y, i). That is, the price level is directly related to the nominal money supply and to real money demand (which is a function of real income and the nominal interest rate).

Using the above relationship between the aggregate price level, nominal money supply and real money demand we may derive a link between inflation, growth in the money supply and growth in money demand. Inflation is just the growth rate of aggregate prices and from the relationship P = M/L^d(Y, i) we get, using the fact that the growth rate of a A/B is equal to the growth rate of A minus the growth rate of B, = %P = %M - %L^d(Y,i). That is, inflation is equal to the growth rate in the nominal money supply (controlled by the Fed) minus the growth rate in real money demand.

Notice that if the growth rate of the nominal money supply is equal to growth rate of money demand then inflation is equal to zero. Now money demand grows over time primarily because the real economy grows over time (average real growth is about 2.5% per year on average). As Y grows individuals consume more and thus need more money to conduct transactions. Since money demand is a function of both Y and i we can use a trick from calculus - the total derivative - to decompose the growth of money demand as follows: %L^d(Y,i) = e_Y*%Y + e_i*%i, where e_Y = income elasticity of money demand and e_i = nominal interest rate elasticity of money demand. Economists estimate that e_Y is approximately 2/3, for the U.S., and that e_i is approximately -1/10 so that money demand is much more sensitive to changes in income than to changes in the nominal interest rate. Further, the growth rate of the nominal interest rate is on average about zero (interest rate on average do not tend to go up or down). These data facts tell us that the nominal interest component does not contribute much to the growth rate of money demand and a reasonable good prediction model for inflation become: = %P = %M - (2/3)*%Y.

An example

Suppose the Fed sets money growth, %M, equal to 6% per year, the annual real economic growth, %Y, is 3% and that the income elasticity of money demand is 2/3. Then our prediction for inflation is given by: = %M - (2/3)*%Y = 6% - (2/3)*3% = 4%.

Empirical relationship between money growth and inflation

The tables below show the relationship between actual inflation and money growth in low money growth countries and high money growth countries.

Inflation in low money growth countries: 1986-1989
Country	money growth (% per year)	inflation (% per year)
Chad	-2.1%	-2.7%
Switzerland	4.1%	1.8%
Belgium	5.0%	1.8%
France	5.5%	3.0%
United States	7.0%	3.6%

Inflation in high money growth countries: 1986-1989
Country	money growth (% per year)	inflation (% per year)
Peru	425%	545%
Yugoslavia	358%	305%
Mexico	71%	82%
Poland	47%	68%
Nepal	20%	11.2%

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Last updated on July 18, 1996 by Eric Zivot.

Published on June 3, 2021

Inflation has been top of mind for investors throughout 2021, as a combination of supply chain disruptions and pent up demand have led to higher prices throughout the economy. The question going forward is whether these increases are transitory or permanent. In our view, the risk of sustained inflation is higher now than at any point in recent memory, and we believe that fixed income investors should adopt a defensive posture.

The concept of inflation has evolved over time and is now generally understood to measure price changes for goods and services that are consumed – the inflation that impacts our day-to-day budgets and “feels bad.”

Importantly, increases in asset values such as home prices and equity prices are not considered in official inflation calculations. So, although one could argue that the dotcom boom of the late 1990s and the housing boom of the 2000s were both inflationary episodes, neither factored into the published numbers. These types of inflation are typically dismissed as asset bubbles, with little thought given to how they might add inflationary pressure to the broader economy.

Whether this is the right way to measure inflation and guide policy is a worthy debate topic, but is not the subject here – which is to evaluate the current “feel bad” inflation and assess whether it is transitory or persistent.

One of the trickiest aspects of inflation is that it is difficult to quantify, as the U.S. economy is both vast and complex. No single measure is able to capture price changes across such a diverse, dynamic landscape.

Probably the best-known inflation statistic is the Consumer Price Index (CPI), which measures the monthly price changes of a static basket of consumer goods as well as food and energy. Core CPI, which excludes food and energy prices, is another well-known indicator. The Federal Reserve (Fed) prefers Core CPI for its policy decisions because food and energy are both susceptible to transient supply shocks (typically caused by acts of nature). These shocks are neither reflective of economic activity nor within the Fed’s control, so they do not want them influencing interest rate policy. The Fed also uses the Personal Consumption Expenditures (PCE) Co