According to the general monetary model with the purchasing power parity, if there is a permanent increase of 2 percentage points in the domestic money supply growth rate, other things equal, then the long-run growth rate of the real money balance (M/P) of the domestic country:

Question

According to the general monetary model with the purchasing power parity, if there is a permanent increase of 2 percentage points in the domestic money supply growth rate, other things equal, then the long-run growth rate of the real money balance (M/P) of the domestic country:

BlackTom AI · Accepted Answer

The question asks about the long-run effect on the growth rate of real money balances (M/P) under the general monetary model with purchasing power parity, given a permanent 2 percentage point increase in the domestic money supply growth rate.
Option a: falls by 2 percentage points. This would imply that a higher money growth rate reduces the long-run growth of M/P by the same amount. However, in the long run, prices adjust one-for-one with money supply changes under PPP, so real balances do not systematically fall by the same increment in growth rate; this option misstates the mechanism.
Option b: falls by 4 percentage points. This suggests a larger, double effect, which is not supported by the standard PPP-based monetary framework. The long-run relation is not that the real money balance growth rate declines by a compounded amount due to a permanent money growth change.
Option c: rises by 2 percentage points. If the domestic money supply grows faster, the price level tends to rise proportionally in the long run (inflation), but real money balances (M/P) move in response to changes in price levels and money stock in a way that leaves their long-run growth rate unaffected under PPP; thus this option misattributes the direction and magnitude of the long-run effect on M/P.
Option d: does not change. In the PPP-based general monetary model, a permanent shift in the money growth rate alters inflation and the nominal variables, but the long-run growth rate of real money balances remains anchored, because any one-for-one price level adjustment offsets the effect of higher money growth on M in real terms. Therefore, the long-run growth rate of M/P stays unchanged.
Thus, the correct interpretation is that the long-run growth rate of real money balances does not change when money supply growth changes permanently, aligning with option d. The reasoning hinges on PPP linking price level changes to money growth over time and the property that real balances grow at the same rate as real income minus inflation expectations in the long run, resulting in a net zero change to the M/P growth rate in the steady state.

According to the general monetary model with the purchasing power parity, if there is a permanent increase of 2 percentage points in the domestic money supply growth rate, other things equal, then the long-run growth rate of the real money balance (M/P) of the domestic country:

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