Question

Using time series diagrams, illustrate how this decrease in the money growth rate affects the money supply MK; South Korea’s interest rate; prices PK; real money supply; and Ewon/¥ over time. (Plot each variable on the vertical axis and time on the horizontal axis.)

Answer 1

According to simple monetary model, inflation rate is equal to money supply growth minus the real output growth rate. If money growth rate decreases, then inflation rate falls (given that real output Growth remains same).

Therefore, money supply falls. along with that, inflation rate falls. Let T be the time period when the money supply is reduced.

Money supply is denoted by and inflation rate is denoted by . Subscript 1 denotes the time period before the money supply growth fall and 2 indicates the time period when money growth rate is decreased.

Since both and falls, the difference between them remains the same. Hence the growth of real money supply remains the same as it was before.

All the variables are plotted in figure 1.