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

What will be an ideal response?

ANSWER:

Seignorage equals the rate of growth of H times real money balances. In the short run, the increase in money growth will likely cause an increase 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 rise and i will likely fall so H/P will increase. In the medium run, Y will not change. The increased money growth will cause an increase in inflation and an increase in the nominal interest rate causing H/P to fall. Therefore, the effects of an increase in money growth on seignorage are ambiguous.