Question

5. Part a: Use the equation of exchange to derive a relationship between the inflation rate and the growth rate of the money stock. What assumptions did you make?

Part b: Milton Friedman stated, “Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.” Consider the following.

i) Since 2006, what has been the behavior of the monetary base? ii) Since 2006, what has been the CPI inflation rate?

Support your answer with graphs.

Explain the divergence of the empirical evidence and the theoretical predictions regarding inflation.

Answer 1