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The Supply and Demand For Money

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As Milton Friedman (1975) said: “ The special conditions that drove up to the price of oil and food required purchasers to spend more on them, leaving them less to spend on other items. Did that not force other prices to go down, or to rise less rapidly than otherwise? Why should the average level of prices be affected significantly by changes in the price of some things relative to others? ” (Milton Friedman, 1975)But when it comes to practical approach, apparent motion in relative prices does affect the total price level due to nominal inflexibilities.

Consequently jumps in the price of oil, for instance, helps in explaining transitory periods of sharp gains in the general price level. Still, it cannot be explained as to how they alone could make clear the steady growth of high inflation. There has to be a policy accommodation i. e., elaboration of monetary policy in response to a negative supply shock. “ Policies that expanded the money supply to avoid a still deeper oil shock-driven recession succeeded in transforming what was a temporary burst of inflation into a permanent jump in the level of inflation” (Taylor, 1999 and Clarida et al. , 2000). Additionally, the fundamental query is whether these shocks strike core inflation as it is this that policymakers can purely aim to control.

This, in turn, reckons on how anticipations are shaped. These anticipations, in turn, touch the current state of the economy because they are included in wages via forward-looking labour contracts. In noetic prospects, model expectations are reliable with the predictable actions of the policymaker. When agents suppose policymakers to adapt unfavourable shocks, expected inflation is likely to rise.

This characterization entails that price level shocks can transfer current inflation even without monetary accommodation, but cannot become deep-rooted in the predictable inflation rate due to the lack of policy accommodation.    

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