Question

In this problem we will study the predictions of the Quantity Theory of money using some real world data for the U.S.

Here is our data (these are the most recent observations I could find).

Money Supply (M) = 5,395 (billions of $)
Monetary Base (B) = 4,807 (billions of $)

1. A few days ago, I received an email notification saying "New York Fed purchases $12.801 billion in Treasury coupons". For simplicity, we will use 12.8 (billions of $) in our computations.

What is the change in M that we can expect from this open market operation implemented by the New York Fed? _________ (billions of $)

2. According to the Quantity Theory of money, what is the inflation rate that will be originated by the open market operation implemented by the New York Fed? _________ %

Answer 1

Money multiplier = Money supply / monetary base = 5395/4807 = 1.1223 = 1.12 ( for simplicity)

1. If New York Fed purchases $12.801 billion in Treasury coupons, it means that moeny supply in the market increase by 12.8 billion* multiplier

change in M that we can expect from this open market operation implemented by the New York Fed = 12.8billion*1.12 = 14.336 billion

= 14.34 billion ( two decimal place)

2.

According to the Quantity Theory of money

MV = PY

%Change in M + %change in V = %change in P ( inflation) + %change in Y ---- (1)

As nothing isgiven about V and Y so we assume that they are constant and change =0

% change in M = [14.34 billion/ 5395 billion]*100 = 0.2658%

Put values in (1), we get

0.2658 + 0 + % change in price ( inflation) + 0

Inflation = 0.2658% = 0.27% ( rounded to two decimal place)