Why is inflation higher than money growth in high-inflation countries and lower than

money growth in low-inflation countries?

ANSWER:

The rise in prices of goods and services in a nation over time is known as inflation. Money
growth is the rise in a nation's money supply over a specific time frame. Money growth and
inflation are correlated; as money growth grows, so does inflation.

Using the quantity theory of money, which is given by

M×V=P×Y
V is for the velocity of money, which is the frequency with which a unit of a certain
currency is used to buy things in a given year. M stands for the money supply, P for
the price level, and Y for the output of the economy.
Inflation results from an increase in the money supply while maintaining the same money
velocity and production. As a result, rising prices lead to higher inflation when the money
supply expands more quickly than economic growth. Similarly, raising the velocity of money
raises the price level raises inflation while maintaining a steady money supply and
production.

Therefore, the velocity of money is high in high-inflation countries, which results in

higher prices and more inflation than money growth. Similar to this, low money
velocity in nations with low inflation results in lower prices and lower inflation than
money growth.
As a result of the aforementioned factors, inflation may be lower than money growth
in nations with low inflation and greater than money growth in those with high
inflation. 

Explain why giving an independent central bank control over the quantity of money in
the economy should reduce the occurrences of periods of extremely high inflation,
especially in developing economies.

ANSWER:
Inflation is a monetary phenomenon and the quantity theory of money states that high
growth in money and high inflation rates both goes together. The central bank of the country
can influence the supply of the money in the economy which is equal to demand of money in
equilibrium and it is also equal to quantity of money in the economy. Therefore they can also
influence the growth of money if they are working independently to control over the quantity
of money in the economy. They can take into consideration the concerns for inflation when
deciding how much money to print. Maintaining the independence of central bank is
sometime difficult in developing economies as the interventions of government is more in
monetary policy of such countries. Therefore giving an independent central bank control over
the quantity of money in the economy can reduce the occurrences of periods of extremely
high inflation, especially in developing economies.

If velocity were constant at 2 while M2 rose from $5 trillion to $6 trillion in a single

year, what would happen to nominal GDP? If real GDP rose 3 percent, what would be
the level of inflation?

ANSWER:

If velocity were constant at 2 while M2 rose from $5 trillion to $6 trillion in a single

year, what would happen to nominal GDP?

growth + velocity growth = growth of nominal GDP.

Nominal GDP would rise by (6-5)/5*100% = 20%

If real GDP rose 3 percent, what would be the level of inflation?

Nominal GDP growth = inflation + real growth.

Inflation would equal 20%-3% = 17%

According to Irving Fisher, when velocity and output are fixed, the quantity
theory of money implies that inflation equals money growth. What does the
quantity theory imply for inflation in the long run in an economy with growing
output and stable velocity?

ANSWER:

Irving Fischer simply suggests that there is proportional relationship between the
Money growth and inflation rate. If Quantity of money is increased by 10 %, price
level will rise by 10 % as well. Further , the value of money will decrease by 10 %. It
is assumed that there is no scope for increasing output level so there is one to one
relationship between quantity of money and price level.

Moving on, If we consider that output level would grow or rise, One to one
relationship between money growth and price will not hold true. Some of rise in
quantity of money will be internalised by the rise in output level. Thus, there might be
some rise in price level if output is not enough to cover the rise in quantity of money.
thus over the long run, there will not be proportional relationship between quantity of
money and price level.

If velocity were predictable but not constant, would a monetary policy that
fixed the growth rate of money work?

ANSWER:

We are aware that inflation equals plus velocity growth. Fixing the growth rate of
money will cause inflation if velocity is not constant. To stabilise inflation, authorities
might, however, raise the money supply at the same pace that velocity is declining if
velocity is predictable.

The link between inflation and the money supply is not as strong if the income
velocity of money is not constant. Even though the growth rate of the money supply
is constant, inflation will change if the growth rate of velocity is not.