Monetary and Supply-Side Policy: Question 5
Syllabus 4.3
A country's central bank significantly increases the growth rate of the money supply, while all other economic conditions remain unchanged.
Which outcome would this be most likely to cause?
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Worked solution
Step 1: Recall what a change in the money supply is
The money supply is the total quantity of money circulating in an economy. Changing its rate of growth is one of the monetary policy measures a central bank can use, alongside changing the interest rate and the exchange rate.
Step 2: Trace the effect of faster money supply growth
If the money supply grows significantly faster while the quantity of goods and services produced stays broadly the same, there is more money available to be spent, but not more goods and services for it to be spent on. With more money chasing a roughly fixed quantity of output, demand for goods and services rises and firms find they can raise prices, pushing the inflation rate up, not down.
Step 3: Why the other options are wrong
- A: This reverses the true relationship, more money chasing the same output raises prices; it does not lower them.
- C: A faster-growing money supply is generally linked to easier, more available credit, not a fall in lending.
- D: Privatisation is a supply-side policy measure, not something caused automatically by a change in the money supply; the shared word “supply” does not connect these two concepts.
Final answer
The most likely outcome is a rise in the inflation rate, option B.