Question

Suppose price levels were falling 10% per day. How would this affect the demand for money? How would it affect velocity? What can you conclude about the role of velocity during periods of rapid price change?

Answer 1

By increasing the amount of money in the economy, the central bank encourages private consumption. Increasing the money supply also decreases the interest rate, which encourages lending and investment. The increase in consumption and investment leads to a higher aggregate demand.