Online test 1 memo unit 1 and 2 2022

In 2010, the central bank of a developing country published an inflation target of 1-3%. In 2010, the
money supply increased from 6 billion dollars to 8 billion dollars and real GDP grew from 5 billion dollars
to 6.7 billion dollars. Assuming velocity was constant, according to the quantity theory, was the money
growth consistent with the inflation target? Explain

Answer:

We showed in part (i) that a theory of inflation can be derived from the quantity theory of
money, i.e. 𝜋=%Δ𝑀−%Δ𝑌
We make use of this relationship to solve part (ii)
%Δ𝑀=$8𝑏𝑖𝑙𝑙𝑖𝑜𝑛−$6𝑏𝑖𝑙𝑙𝑖𝑜𝑛/$6𝑏𝑖𝑙𝑙𝑖𝑜𝑛×100%=33.33%
%Δ𝑌=$6.7𝑏𝑖𝑙𝑙𝑖𝑜𝑛−$5𝑏𝑖𝑙𝑙𝑖𝑜𝑛$5𝑏𝑖𝑙𝑙𝑖𝑜𝑛×100%=34%
𝜋=33.33%−34%=-0.7%
The realized inflation is -0.7% which is a deflation issue and not consistent with the central
bank target of 1%-3%.

Explain how the 4 factors in Friedman's modern quantity theory can lead to an increase in money
demand?

Increase in permanent income

Decrease in return on bonds, equity and return on goods

Below you will find 3 South African diagrams on M3 growth, prime interest rate changes and CPI, explain
using your knowledge of unit 1 the relationship between the 3 variables (use the long-run trend)

Please focus on the effect of these indicators on money supply

M3 increasing trend

Prime rate decreasing trend

CPI increasing trend

Answer: Overall we can observe a positive relationship between CPI and Money supply in SA. Also we
observe that these 2 variables have a negative relationship with interest rates.
Briefly explain how interest rates influence the demand for money within the Keynesian theory of
expectations

According to the Keynesian theory there is a negative relationship between interest rates and demand for
money. The theory is based on expectations and interest rate settling at some normal value. For example
if interest rates increases (above its normal value) people expect it to decrease in the future. Since they
expect a decrease in interest rates in the future, they also expect an increase in the price of bonds. It
therefore becomes more valuable to hold bonds and people will demand less money holdings

Assume there is an increase in the demand for equities and shares on the online streaming platform
market (like Netflix). How will the demand for money be influenced?

An increase in demand for Netflix shares will lead to an increase in price of these shares. This will then
decrease the return on these shares and increase the demand for money holdings