At the end of the third quarter of 2015, the money supply in the U.S. was $2 tri
ID: 1206697 • Letter: A
Question
At the end of the third quarter of 2015, the money supply in the U.S. was $2 trillion. That is, the available currency and deposits in the U.S. during July, August, and September 2015 was two trillion dollars. Also, during the third quarter of 2015, U.S. nominal GDP was $16 trillion and U.S. real GDP was $13 trillion.
During the third quarter of 2015, which of the answer choices gives the best approximation of the maximum number of times that a given dollar bill was exchanged during legal transactions?
A. More information is needed; specifically, the price level must be known.
B. Six and a half times
C. Eight times
D. Sixteen times
Monetary Neutrality is a theory in macroeconomics that states when the central bank conducts monetary policy, the central bank does not affect the real economy (e.g., the number jobs, the size and growth of output, the amount of investment). Instead, any change in the money supply would be offset by a proportional change in prices and wages. Monetary neutrality underlies the quantity theory of money. Suppose that throughout the fourth quarter of 2015, the Federal Reserve enacted a bond buying program. If monetary neutrality holds, then which of the answer choices is correct?
A. During the fourth quarter of 2015, the Fed conducted a contractionary monetary policy. From the third quarter to the fourth quarter, U.S. money supply decreased, and U.S. nominal GDP decreased.
B. During the fourth quarter of 2015, the Fed conducted a contractionary monetary policy. From the third quarter to the fourth quarter, U.S. money supply decreased, and U.S. nominal GDP was unchanged since it is not affected by changes in monetary policy.
C. During the fourth quarter of 2015, the Fed conducted an expansionary monetary policy. From the third quarter to the fourth quarter, U.S. money supply increased, and U.S. nominal GDP increased.
D. During the fourth quarter of 2015, the Fed conducted an expansionary monetary policy. From the third quarter to the fourth quarter, U.S. money supply increased, and U.S. nominal GDP was unchanged since it is not affected by changes in monetary policy.
Explanation / Answer
The number of times a dollar exchanges hands is explained through the Velocity of Money Concept. The velocity of money is the average frequency with which a unit of money is spent in an economy. Velocity of Money = Nominal GDP/Money Supply Velocity of Money = $16 trillion/$2 trillion = 8 times (Option C) A bonds buying program by the Federal Reserve indicates that the flow of credit in the economy would increase. If bonds are bought by the Federal Reserve, more money will flow in the hands of the commercial banks and thus they would lend more. Therefore, the Federal Reserve conducted an expansionary monetary policy. Further, Monetary Neutrality states that a Monetary Policy measure would not affect the REAL variables in the economy but would only affect NOMINAL variables. Thus, The U.S. Nominal GDP would increase Answer C is correct Hope it clears your doubts:-)
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