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    Theory of money and deflation

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    Three questions:

    Outline the Quantity theory of money and it's theory of inflation.

    What effect will deflation have on the economy?

    If the deflation is acute and lasts only a short time, how will the effect differ from deflation that lasts a long time and is gradual?

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    Solution Preview

    The theory of inflation can be succinctly stated by the Equation of Exchange: MV = PT, where M is money, V is velocity, P the price level and T the level of transactions. Because output is given by the real side and the demand for money is an institutional arrangement, then V and T are more or less fixed. The only variables which remain, then, are M and P. If the equation above holds at all times, then if M rises, we necessarily need P to rise by the same amount. Thus, money supply expansions only cause price inflation. This is the Quantity Theory of ...

    Solution Summary

    The story discusses the theory of money and deflation.