[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

What happens if the supply of money increases? At the initial price level P, individuals
are now holding more money than they want to. The easiest way to reduce
the amount of money you are holding is to spend it. From the perspective of firms,
increased spending by consumers provides a signal to increase prices. Faced with
higher prices, workers demand high nominal wages. As prices rise, individuals must
hold more money to carry out the same transactions. Equilibrium between demand
and supply for money is restored when prices have risen enough that the increase
in the quantity of money demanded equals the increase in the money supply. Nominal
wages will have risen by the same proportionate amount to maintain the real wage
at the level that clears the labor market and maintains full employment. An increase
in the money supply leads to an increase in the general level of prices and nominal wages.
In the labor market, as noted, the increase in the price level will be matched by
an increase in the nominal wage, so that the real wage remains at its original level.
At this real wage, the demand for labor continues to equal the supply of labor. Thus
the effect on the labor market of an increase in the price level is simply a proportionate
increase in the nominal wage. There are no real effects—the equilibrium
real wage and the equilibrium level of employment are unaffected.
In the capital market, real saving and investment both depend on the real interest
rate, which is not affected by the increase in the price level. Accordingly, the
equilibrium real interest rate remains unchanged. Only the nominal levels of saving
and investment change in proportion to the change in the price level.
We can say something more about how much the price level will increase if the
money supply rises. We have assumed the demand for money is proportional to GDP.
If the money supply rises by 10 percent, GDP must rise by 10 percent to ensure that
the money demand increases by the same amount as the money supply. With fullemployment
output unaffected, this means that the price level must also rise by
10 percent. The aggregate price level will move in proportion to changes in the
money supply.
Most economists agree that in a full-employment economy, a onetime change in
the money supply affects the price level but little else in the long run. In particular,
it does not affect the quantity of goods and services produced or the number of workers
employed. An imaginary example may help us understand the point. Suppose
that instantaneously, the entire supply of money in the economy was increased by
a multiple of ten. In effect, we have tacked a zero onto the money supply. Stores,
Internet Connection
HOW MUCH CASH DO WE HOLD?
The Web site at the Federal Reserve Bank of Atlanta provides
some facts and figures on America’s money. For instance, did
you know that in 1920, we had just over $50 in cash per person,
while by 2000 this figure rose to over $2,000? Check out the site
at www.frbatlanta.org/publica/brochure/fundfac/html/home.html.
610 ∂ CHAPTER 28 MONEY, THE PRICE LEVEL, AND THE FEDERAL RESERVE