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A plot of Canadian inflation against annual money growth rate between 1971 and 2011
shows ____.
A) money supply lags by two years
B) money supply lags by one year
C) that the two are contemporaneously correlated
D) are uncorrelated
Answer: A
Diff: 2 Type: MC Page Ref: 530
Skill: Recall
Objective List: 21.1 Describe how the demand for money is determined
Give the equation of exchange and explain the variables used in it. Why we call it an
identity?
Answer: The equation of exchange is given by M x V = P x Y, where M is the money supply, V
is the velocity of money, P is the price level and Y is aggregate output or income. It is an identity
because it is a relationship that is true by definition. It does not tell us, for example, that when the
money supply M changes, nominal income (P x Y) changes in the same direction: a rise in M for
example could be offset by a fall in V that leaves M x V unchanged and therefore P x Y
unchanged.
Diff: 2 Type: SA Page Ref: 526
Skill: Recall
Objective List: 21.1 Describe how the demand for money is determined
Explain the conclusion that the quantity theory of money is a good theory of inflation in the
long run, but not in the short run. How does is this conclusion related to flexible wages and
prices.
Answer: Inflation is always and everywhere a monetary phenomenon. is accurate in the long run
but not supported empirically in the short run. The classical assumption that wages and prices are
completely flexible may not be a good assumption for short-run fluctuations in inflation and
aggregate output.
Diff: 2 Type: SA Page Ref: 530
Skill: Recall
Objective List: 21.1 Describe how the demand for money is determined