Money, BankingCountries A and B both have the same money growth rate and in both countries, real output is constant. In country A velocity is constants while in country B velocity has fallen. In...
Countries A and B both have the same money growth rate and in both countries, real output is constant. In country A velocity is constants while in country B velocity has fallen. In which country will inflation be higher? Explain why.
Essentially, the excess printing of money beyond commodity output results in inflation. Here, when Country A continues to print money, Country B slows its money production. This allows Country B's commodity output to create salable value rather than paper value; their money is backed by a strong economy, so its real value increases. Country A, however, is still printing money without increasing commodities, so their money is decreasing in value.
The quantity theory of money states that the inflation rate in Country A will be higher. The reason for this is that the velocity of money in that country is higher. Since P = (M*V)/Q and both countries have the same real output and money growth rate, the only difference between them will be "V" and therefore the value of P in country A will be greater.
Even without the impressive use of equations, simple logic dictates that the inflation will be higher because the one factor that has changed, the variable, is the velocity. This would therefore in turn show that the inflation is something that would be higher in A as a lower velocity is one factor that can lead to a lower inflation.