The oldest idea in macro: money growth and inflation in the long run.
Warming up the engine…
The classical link between money and prices: money times the speed it circulates equals the price level times output, so with stable velocity and full-employment output, money growth becomes inflation.
M·V = P·Y ; %ΔM + %ΔV = %ΔP + %ΔY
If the money supply doubles but the economy produces the same real output, twice as many dollars chase the same goods and prices eventually double. This holds impressively well across countries and decades for high inflations; it slips in the short run, when velocity moves and output responds.
Use the growth-rate form: inflation ≈ money growth minus real output growth (with V stable). State the assumptions (stable V, Y at potential) or you have not answered the question.
Now prove you have it
Move the curve to where you think it lands, and get told exactly which part you got right.
Real-world scenarios on this model
Equilibrium at M 40, P 40.
Equilibrium: M* = 40.0, P* = 40.0
Current equations
MV = PY, rearranged into a line: for a given velocityvelocityHow many times a unit of money changes hands per period, the V in MV = PY. and realrealAdjusted for inflation, measured in actual purchasing power. output, the price level is proportional to money. Slide M right and P follows, print twice the money, get twice the prices, eventually.
Source: Mankiw, Macroeconomics, ch. 5