Analysis a relationship about economic - Statistics Project Example

Task: Relationship between Money Growth/Supply and Inflation Inflation refers to the unrelenting upsurge in the prices in an economy. When inflation ensues, the buying price of a currency entity wears down, meaning, therefore that a person would require more money in order to purchase the same product. A number of economists are of the idea that there exists a straight correlation between the money under circulation and the inflation rate. However, considering other factors in play affecting inflation, determining the connection between circulating currency and inflation is not as easy and predictable as it may seem (Mishkin, 28).

The money in supply and inflation rate is always interconnected because a high amount of money in supply usually devalues demand for money. For instance, in a small town if all residents were to get $50 raise in their salary each month, if they were paying about $14 on their gas, then with the rise they will likely not mind paying $15 given the fact that it is relatively less than what they normally spent on gasoline per week. In most cases, this is normally how the relationship between inflation and money often starts, when the market is able to bear high prices due to increase in the money supply (Mishkin, 40).

Therefore, most customers will most likely opt out of buying a product at the same price it was before the inflation occurred simply because the buying power of the currency has been worn out.The graph above shows the estimated value of the relationship between inflation and money growth. The rate of inflation depends on the amount of money in supply. When one takes into consideration the classical theory, money does not affect real variables but has an effect on nominal variables such as inflation.

This, therefore, means that when plotting the graph, the rate of inflation will be plotted on the y-axis while the supply of money will be plotted on the x-axis. The blue dots are the actual values while the red line shows the fitted values.In the long run, the correlation between money and inflation is rather high and can be estimated to almost one. However, when the short term period is taken into consideration, the relationship between money and inflation is rather weak which could be an attributing factor as to why the curve showing the relationship between money and inflation is not straight.

Several economic theories can be applied in order to try to explain the relationship between money supply and inflation. If one were to use the quantity supply theory, also refers to as monetarism, the relation between money in supply and inflation is stated as MV=PT. Simply put, this implies that money multiplied by its velocity equals the price of products in the market and the transactions. In this case, transactions and velocity are the constants, while the supply of money and prices of the products are directly related (Mishkin, 52).

On the other hand, in the Keynesian theory, although there still exists a relationship between money and inflation, it however is not the only factor that can affect inflation and prices in the market. Generally, the theory emphasizes on the relationship between total demand and the changes in inflation.In most instances, you find that money supply controls inflationary conditions in a country. When a country is trying to lower the rate of inflation, the central bank will most likely lower the borrowing rates and increase their interest rates.

However, when the interest rates drop below a certain level, these standards can be relaxed as a way of stimulating the economy. Normally, most countries implement a central banking system to establish lending and interest perimeters depending on the economic data.Work CitedMishkin, Frederic S. Money, Interest Rates and Inflation. Aldershot u.a: Elgar, 2003. Print.