THE EFFECTS OF A MONETARY INJECTION

Let’s now consider the effects of a change in monetary policy. To do so, imagine that the economy is in equilibrium and then, suddenly, the Fed doubles the supply of money by printing some dollar bills and dropping them around the country from helicopters. (Or less dramatically and more realistically, the Fed could inject money into the economy by buying some government bonds from the public in open-market operations. WhatWhat happens after such a monetary injection? How does the new equilibrium compare to the
old one?

Figure 2 shows what happens. The monetary injection shifts the supply curve to the right from MS1 to MS2, and the equilibrium moves from point A to point B. As a result, the value of money (shown on the left axis) decreases from , and the equilibrium price level (shown on the right axis) increases from 2 to 4. In other words, when an increase in the money supply makes dollars more plentiful, the result is an increase in the price level tilat melees each dollar less valuable.

Figure 2 An Increase in the Money Supply

Economy determines the value of money, and growth in the quantity of money is the primary cause of inflation. As economist Milton Friedman once put it, Inflation is always and everywhere a monetary phenomenon.