Long Run Neutrality of Money

Long Run Neutrality of Money

Short Run

• When the central bank increases the money supply it causes the interest rates to

  decrease

  ---

• This causes Aggregate

  Demand

  ---

  to shift to the

  right

  ---

• The equilibrium price level

  increases

  ---

  and the output

  increases

  ---

  , which leads to an

  inflationary

  ---

  gap (boom).

Long Run

• The inflationary gap causes wages to eventually

  increase

  ---

• This causes Aggregate

  Supply

  ---

  to shift to the

  left

  ---

• The equilibrium output goes back to the original level and the price level goes even higher
• In the long run, higher money supply has no effect on the output, it only leads to higher inflation.