Explain The Relationship between money supply and inflation Essay

Explain The Relationship between currency supply and ostentatiousness - Essay sheathSince high ostentatiousness rate decreases the nominal value of money, demand for money decreases (Gafar 2003, p. 101 International pecuniary Fund 1996, p. 106). This makes demand for money less sensitive to high lump rate (Sussman and Zeira 2003). High puffiness could impede the overall economic suppuration in UK. Each time UK is facing high inflation rate, it is expected that the real value of money decreases. At this point in time, abundant supply of money circulates in the entire UK economy. For this reason, the worths of local goods and services tend to increase. Since the nominal value of money decreases, busy place and minimum wage requirements could increase (International Monetary Fund 1996, p. 101). In order to ascendency the adverse economic effect of high inflation rate, monetary policy should be use in order to control the supply of money that circulates in UK. To allow the rea ders consent a better understanding about this subordinate matter, this report get out focus on discussing the relationship between money supply and inflation. After discussing the relationship between money supply and inflation, this report will discuss how increasing or decreasing the interest rate could affect the increase or decrease in money supply. Relationship between bullion Supply and Inflation In general, central banks do not have a direct office to improve economic emersion. Given that money supply has a significant role in the movements of inflation rate (Basco, DAmato and Garegnani 2009), central banks control the money supply by manipulating the levels of short-term interest rates at the point wherein the central banks could control high inflation rate from increasing (Gafar 2003, p. 103). Specifically in the quality of European Union, the European Central Bank (ECB) was made responsible in retentivity the market prices of grassroots commodities stable by prev enting inflationary growth (Hossain 2010). High inflation rate contributes to low economic growth as a result of increasing the interest rates and minimum wage requirements (Gafar 2003, p. 102). Since the market price of basic commodities is high at times when inflation rate is high, more people will have difficulty in purchasing basic commodities. Because of high minimum wage requirements, more local businesses will not be able to sustain its daily operational costs in times when sales are down (Laing, Li and Wang 2007). To avoid bankruptcy, a large number of the local businesses are probably to cut down the number of its employees. In the end, this increases the unemployment rate. Monetary equation assumes that a significant increase in the supply of money could result to a significant increase in price provided that velocity and Y are constant MV = PY. In line with this, several studies revealed that the velocity of money is highly correlated with growth in money supply under h igh inflation and vice versa (Basco, DAmato and Garegnani 2009 Dwyer and Fisher 2009). As ramify of controlling the money supply, ECB reported that it is necessary to maintain the Harmonized Index of Consumer Prices (HICP) below but mop up to 2% inflation rate (ECB 2007b ECB 2003). Maintaining inflation rate close or below 2% inflation rate is necessary to ensure that the EU economy will benefit from stable market prices. Likewise, keeping the inflation rate below or close to 2% inflation rate could protect the EU economy from the risk of having