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Unformatted text preview: The effects of a monetary expansion on aggregate spending, output and employment usually begin to show up six to nine months later, that is, with a lag of two to three calendar quarters. Specifically, changes in the growth rate of real M1 (M1 adjusted for price–level changes) tend to be followed about two quarters later by similar changes in the growth rate of real, or inflation–adjusted, gross national product (the nation's total production of goods and services). Changes in the growth of money tend to be followed about six months later by significant changes in the same direction in the growth of the nation's output of goods and services. Historically, monetary expansion also has affected prices, although with a much longer time lag – perhaps two years or more. Thus, the good news of excessive monetary expansion usually comes first and the bad news later. Output and employment rise initially, and prices follow some time later. The explanation for this sequence is that output and employment eventually grow beyond the point where labor supply and demand are balanced. After that point, firms bid up wages in excess of labor productivity, leading to increases in unit costs and prices. Rising prices then squeeze the economy's financial liquidity as they reduce the purchasing power of the nation's money stock. Interest rates begin to rise and dampen spending. Output and employment consequently tend to move back to the levels that existed before the monetary expansion began. By the time the price effects of an excessive monetary expansion are felt in their entirety, the stimulus to output and employment may have largely evaporated. The task of fighting inflation is complicated by the different lags in the impacts of monetary policy on output. To avoid spurring inflation, policymakers must guard against staying with expansionary policies too long, although this may be difficult to do since the
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This note was uploaded on 12/30/2010 for the course SOC 101 taught by Professor Zhung during the Spring '10 term at Punjab Engineering College.
- Spring '10