AP Macroeconomics AMSCO Guided Notes
5.3: Money Growth and Inflation
AP Macroeconomics Guided Notes
AMSCO 5.3 - Money Growth and Inflation
Essential Questions
- How does monetary policy affect inflation?
I. Inflation and the Value of Money
1. What is inflation and why does the Federal Reserve target a 2 percent annual inflation rate?
A. Measuring Inflation
1. What are the Consumer Price Index (CPI) and Personal Consumption Expenditures Price Index (PCE), and why does the Federal Reserve prefer to use the PCE?
2. How does inflation affect the purchasing power of money over time?
B. The Value of Money
1. How does inflation change the value of money and what does this mean for consumers?
II. Money Supply and Money Demand
1. How does the Federal Reserve control the money supply and what role does the money multiplier play?
2. What factors determine the demand for money and how does the price level affect the quantity of money demanded?
A. The Quantity Theory of Money
1. What is the quantity theory of money and what does the Fisher equation (M × V = P × T) represent?
2. How does an increase in the money supply affect the price level and what happens to the equilibrium between money supply and demand?
3. Why should a decrease in the money supply be gradual, and what is the relationship between money supply growth and inflation in the long run?
B. The Velocity of Money
1. What is the velocity of money and how is it calculated?
2. What does the velocity of money indicate about an economy's health, and why did velocity drop significantly in the second decade of the 21st century?
III. The Taylor Rule
1. What are the three factors that the Taylor rule uses to determine appropriate interest rates?
2. How does the Taylor rule guide the Federal Reserve in setting interest rates in response to inflation and employment changes?
Key Terms
quantity theory of money
equation of exchange
velocity