Suppose the central bank decreases the rate of growth of the money supply. What effect will this decrease in money growth have on seignorage in: (1 ) the short run; and (2 ) the medium run? Explain.

What will be an ideal response?


Seignorage equals the rate of growth of H times real money balances. In the short run, the decrease in money growth will likely cause a reduction in seignorage as long as H/P does not change or does not fall significantly. H/P is a function of real income and the nominal interest rate. In the short run, Y will fall and i will likely rise so H/P will decrease. In the medium run, Y will not change. The decreased money growth will cause a reduction in inflation and a reduction in the nominal interest rate causing H/P to increase. Therefore, the effects of a decrease in money growth on seignorage are ambiguous.