Government Spending does not cause Inflation.
Yash Moitra, Pooja Sharma
With post-recessionary Government Spending, there have always been concerns of inflation. To validate this, we employ the
Government Spending Multiplier, which must always remain above 100%, that is 1, for there to be no inflation. When
considering the practicalities of Marginal Propensities to Consume and Save, we can conclude that on a theoretical level, the
multiplier does stay above 1. Once we establish this, we move forward and work with monetary applications and the way in which
governments apply them, specifically looking at interest rate fluctuations, wherein we examine money supply and money demand,
and the effects of their alterations. Herein, we see that the money supply does not influence rates of interest either. As part of the
analysis, the paper also looks at how assumptions like Ricardian Equivalence and holding Money Velocity constant affect the
extent of inflation, if there is any. The overarching conclusion remains that Government Spending does not cause Inflation.
I
Introduction
Throughout history, we have seen government spending go up after recessions to boost aggregate demand. This has been evident
in financial crises, especially in the last century. As many nations emerge from the COVID crisis (Jenkins and Jones 2020), we
have seen an unprecedented rate at which Governments have been spending to ease the effects of the lockdown-induced
recessions (International Monetary Fund 2021) (Nahata 2021) (The World Bank 2020). With this in mind, many perspectives have
remained cautionary of excessive expenditure leading to inflation within economies, and this has caused much concern. The
foundation of these beliefs is worthy of investigation as it is important to know the real effects of this expenditure on price levels
of commodities and how it will affect people’s living standards. This spending contains not just purely fiscal measures to do with
government budgets financed through taxes but also through deficits and unrestricted borrowing, as well as monetary stimulus via
altering the Money Supply and Demand (Cassim, et al. 2020). This paper will explore the inflationary consequences of doing so,
and model the ideal effects of such measures on price. It will touch upon the fundamentals of macroeconomics to explore such
effects as well.
II
The Primary, Fiscal Effects of Government Spending
A
Establishing the Government Spending Multiplier within context
When working with and trying to gauge the effect of any level of expenditures by the government in macroeconomics, it is
standard to define a value known as the Government Spending Multiplier (GSM), which dictates, as a multiple of itself, the
increase in Aggregate Demand or stimulation to the economy a certain amount of Government Spending would have (Federal
Reserve Bank of St. Louis 2017). Herein, it is important to define the Marginal Propensity to Consume (MPC), which can
essentially be used as an assumption for the probability that an additional unit of income would be used towards consumption or
not (Investopedia 2019). For the sake of simplicity, it is assumed that income will either be spent or saved, wherein saving may
constitute any activity that is not immediately creating output or constituting an expenditure on behalf of the consumer, such as
investment, putting income in the bank, or simply not using it. It is also important to keep in mind that savings, especially in
banks, also may act as a stimulus due to the fractional reserve banking system; however, on a macroeconomic scale, this can be
ignored as on average, the overall level of saving in the economy would remain largely unaffected. Due to the binary choice
between the consumption and saving, the Marginal Propensity to Save ( MPS), which can be used as an assumption for the
probability that an additional unit of money would be used towards saved or not, can be defined as 1 − 𝑀𝑃𝐶, wherein both MPC
and MPS are expressed as a probability out of 1, and neither can practically be 1, since no amount of economic theory can predict
human behaviour with full certainty.
Once these values have been defined, we can lay out the GSM, as it stands established. The formula for the GSM is
1
1−𝑀𝑃𝐶
, which
intuitively means the reciprocal of one less the probability that the Government’s Expenditure will be used towards consumption.
1
This can be rewritten as
, since we effectively know that 𝑀𝑃𝑆 = 1 − 𝑀𝑃𝐶. Wherein MPC cannot practically be equal to or
𝑀𝑃𝑆
less than zero and cannot be equal to or more than one, we can know for certainty that the GSM will not be less than one, as MPS
will vary inversely proportionally to MPC, and as MPS stays between zero and one. This happens because it is not possible for a
consumer to spend less than 0% of their income or more than 100% of their income on consumption, hence MPS stays between 0
and 1. Hence, one can state that at least 100% of Government Spending will
contribute to economic growth, since we know that Government Spending is
part of Gross Domestic Product (GDP), using the formula 𝐺𝐷𝑃 = 𝐴𝐷 = 𝐶 +
𝐼 + 𝐺 + (𝑋 − 𝑀), wherein C stands for Consumption, I for Investment, G for
Government Spending, X for Exports, and M for Imports. Using this, it can be
established that ceteris paribus, Government Spending is directly proportional
to economic growth (Hagedorn, Manovskii and Mitman 2019).
B
Reaching a Diagrammatic basis of understanding
This concept remains best explained graphically. In the simplified economy shown (Fig. 1), we assume the Aggregate Supply and
Aggregate Demand curves to be straight lines for conceptual understanding, although kinked curves would yield the same results.
On the graph, the X axis shows GDP or output, and the Y axis shows price level or an equivalent measure thereof. AD is used to
denote a single Aggregate Demand curve, and AS is used for Aggregate Supply. e denotes a point in equilibrium where AD and AS
meet. P is the given price level for a particular point in equilibrium, and Y is the GDP level. In this economy, situation 1 is the
initial stage, and corresponding points can be observed as they are stationary. Situations 2,3, and 4 are possibilities that may occur
in this economy after a particular expenditure by the government, the effects of which are shown by curves corresponding to each
possibility (Dutt 2006) (Farmer 2008).
As established above, we know that at least 100% of Government Spending contributes to GDP, so as AD shifts by a fixed amount
in every situation, we know ∆𝑌 must be equal to or greater than the shift in AD, assuming the Government Spending is positive. In
other words, the distance between the original 𝑌1 and any possible 𝑌2,3,4 must be at least the distance between the original 𝐴𝐷2 and
the changed 𝐴𝐷2 . This is observed graphically and intuitively, wherein the shift in AD is observed as the distance between
hypothetical points 𝑒1 and 𝑒3 . Corresponding to this minimum distance, the least GDP after the change stands at 𝑌3 . With this, we
observe there is no corresponding inflation or deflation. What is important is that the equilibrium in this situation is made possible
by an equal or greater shift in AS, from 𝐴𝑆1 to at least 𝐴𝑆3 . With this rule in mind, we see that situation 2 is impossible to reach, as
it violated the conditions laid out. Hence, an increase in price level, as seen corresponding to situation 2, is also impossible to
reach. A possible situation, however, is situation 4, wherein price actually goes down, or deflates. This is a theoretical possibility,
but the level of deflation depends on the GSM. Putting the graph into perspective, we start to see exactly how it is not possible for
government spending to cause inflation.
C
Contrasts with traditional Keynesian Theory
Traditional Keynesian Theory, at least as it has come to be perceived, rests
with a distinct difference from others in Keynesians’ perception of the true
shape of the Long Run Aggregate Supply (LRAS) curve (Ogujiuba and
Cornelissen 2020) (Healey 1992). In their understanding, it has three stagesthe Keynesian, or depression stage, wherein it has a price elasticity of 1
(shown as a horizontal line); the Neoclassical stage, wherein the curve takes
on a more traditional elasticity and is kinked upwards in relation to the
Keynesian stage (shown as a line with a positive gradient); and the Classical,
or full-employment stage, wherein it has a price elasticity of 0 (shown as a
vertical line). In essence, these three stages of an economy show relatively
large unemployment, transition, and full employment, respectively (Hudea
2015).
On the graph shown in Figure 2, this curve is depicted in the AS Domain, whereas the AD domain remains the same. Price and
Output are shown as stagnant, and the X and Y axes depict GDP and Price Level, respectively. One way that the Keynesian LRAS
curve agrees with our approach is that it shows the Keynesian stage as being perfectly elastic- an important distinction from
previous theories (Coddington 1976). Herein, it claims that any increases in AD will never cause inflation- which our theory does
agree with, however a great limitation herein is the impossibility to see a real increase in LRAS. In other terms, this does not
address the fact that the Long Run Aggregate Supply of an economy does increase with time with respect to technological
breakthroughs. Hence, it makes most sense to display the LRAS with a relative elasticity in non-binary fashion, as shown in
Figure 1 (Salvadori and Panico 2006). With our principles, we would normally assume that the non-inflation would occur due to
an equal or larger shift in AS than in AD, which means there is an inherent change in the actual factors of production. In the
Keynesian stage, however, there is no scope for a change in the actual factors; only for their relative displacement and use. This,
by extension, rules out any changes such as an increase in the Labour force, a change in the kinds of Capital used, an increase in
Land yields, or even an increase in Entrepreneurial spirit. Simply put, this is impractical as a theory, since it is not possible that
there will never be an increase in Aggregate Supply in an economy, even if we only apply the counter-logic to a certain portion of
the Keynesian curve. Another attestation to this is that even a significant redistribution (or the lack thereof) in the use of resources
will very likely spawn a change (negative or positive) in capacity simply by virtue of increased efficiency or even specialisation
(Pasinetti 2005). It can be argued even, that unlike in single markets, in the total economy there can exist no single quantity
supplied, constant or not, without an AS (supply) curve that is variable.
Hence, we can see that Keynesian theory, at least as it is currently defined
and accepted, does not hold up to the circumstances underlined.
D
Contrasts with traditional Classical Theory
Traditional Classical theory is characterised as different from Keynesian
theory in that it theorises the LRAS to be perfectly inelastic, with a price
elasticity of 0, reminiscent of the full-employment stage of the Keynesian
curve. This mainly boils down to the Classical belief that in the long run,
an economy will produce at its maximum capacity (Bruno 1999).
Moreover, it states that this LRAS stands at the full employment rate of the economy, and any equilibria of output above this rate
will always result in an inflationary gap, or thereby a long run rise in price levels (Seeley 2017). According to them, this is the
result of the inflationary gap creating an upward pressure on price levels. An inflationary gap such as the one suggested is shown
in Figure 3, wherein an LRAS curve is illustrated, showing the economy operating, in theory, above the full employment limit as a
result of Government Spending. The situation shown is made possible by the lack of an upper limit to the Government Spending’s
stimulation of AD, hence rendering the LRAS void. The Classical Theory is contradicted by our thesis as by our model, there is
no limit to the increase in AS, and as the government spends more, price levels remain constant, resulting in no inflation, as output
increases with no inherent limit. Herein, we see that the Classical model believes that there will, at some point, be inflation,
however our model refutes that any inflation will occur solely due to government spending, ceteris paribus. In essence, the
existence of inflationary pressure due to an increase in one specific component of AD is missing. This means that classical theory
needs to be rethought in terms of precisely what assumptions it lays upon its models, since not only do the existing ones fail to
hold, even with the ones already given, it is possible to disprove it using the hypothesized modelling shown above.
We see, moreover, that there is a very specific belief in Classical economics that in the long run, a shift in AS is the sole
influencer of price levels, or inflation (Sowell 2006). However, it is evident that AS itself is influenced by a component of AD,
hence the entire concept of there being exclusionary use of these terms must be given due consideration. Also, it is important to
look at the separation of Short-Run Aggregate Supply (SRAS) and LRAS in the Classical models (Aspromourgos 1998), as this
conveys that in the Short-Run, supply across the economy can possibly be vastly more than is ‘possible’ in the Long-Run
(Mariolis and Tsoulfidis 2016). In practical terms, this does not make much sense as it is difficult to even imagine a scenario
where an economy would produce substantially more than it ‘can’, as if there is some point in production that is above what is
technically possible, it must lay outside the Production Possibility Curve, thereby being, by definition, unattainable. Even if it is
assumed that certain factors of production or resources are used from outside the economy (accounting for the increasingly
globalised nature of economics) in the short run to help attain the unattainable, so to say, there is no reason defined clearly as to
why this is not possible sustainably, and/or that this in itself will not help create even more supply, as if the government spends on
the outsourcing of resources, it in itself would spawn a higher AD, and to avoid inflation, a proportionally (at least) higher AS, so
the argument for the long run fails on the basis of simple applicability in both closed and open economies, thereby voiding the
validity of the Classical theory. The only possible resolution to this situation would be that the LRAS would move in conjunction
with the AD-AS equilibrium every time there occurred any Government Spending, but this would render the very existence of an
inflationary gap ineffective in this situation, since there will occur no inflation.
II
The Secondary, Monetary Effects of Government Spending
A
Monetary Policy as an alternative to Government Spending
Monetary policy is the change in interest rates, money supply, or exchange rates made to influence Aggregate Demand.
Expansionary Monetary policy is when these tools are used to increase Aggregate Demand. The immediate purpose of
Government Spending as an expansionary fiscal measure remains to increase Aggregate Demand, as it stands previously defined
(Lin 1994). This is done most immediately by an authority-holding body releasing money, so to say, into the economy, thereby
increasing demand as the money multiplies (using the previously established GSM) (Nuru 2019). As separated, monetary policy is
distinct from fiscal policy in that it is executed by a central bank and not by a government, at least in economic terms (Chari and
Kehoe 1999). However, this distinction becomes problematic and blurry in the real-world scenario where in most cases, the
central bank and the government are under similar influences and pressures, and hence often act in unison. For example, even
seemingly fiscal measures like the stimulus packages approved by the US Congress in 2020 (a government) may go hand-in-hand
with monetary policy, such as the accompanying printing of money by the US Federal Reserve (116th Congress (2019-2020)
2020). Even if explicitly separate, it can be assumed, keeping in mind important precedent regarding transition of power and
distribution of authority, that a both, the government, and the central bank, hold the capacity to act together, under similar
pressures and causes, to obtain similar consequences. Having established this, we can analyse similarities in the effects of their
measures.
Monetary Policy has for long both held and effectively executed the ability to make changes in AD. Policy as such which
increases the latter is termed Expansionary Monetary Policy, and the primary intended outcome of this is to increase the quantity
of money or loanable funds in the market, increasing, by extension, AD. For this purpose, it is often used as an alternative to
immediate or explicit government spending. It remains, however, notable that there are oppositions to this usage of Monetary
Policy as well, most notably through New Classical ideologists (Hudea 2015). The Quantity of Money and Loanable Funds in the
economy can be manipulated by Central Banking Authorities. This can happen in ways that include, but are not limited to,
changes in repo rates, changes in reverse repo rates, the purchase and sale of government bonds, printing or issuing currency,
and/or demonetisation (Gallant 2021).
B
Diagrammatically Representing the twin Money Markets
The twin Money Markets consist of the Short-Run Money
Market, including all M2, and the Long-Run Loanable Funds
Market, including all funds in the economy which can be loaned
out to stakeholders within the economy. Figure 4 shows the
Short-Run Money Market, wherein the hypothetical economy
starts off with a Money Demand (MD) and Money Supply (MS)
curve. The Money Supply is shown to be perfectly inelastic as it
cannot be altered according to differing levels of Demand, since
Money cannot be produced by non-state actors, unlike other
goods and services. This lends itself to the problem wherein an
increased Demand for Money manifests in the form of an
increased Interest Rate. In this economy, there is a hypothetical
increase in the Money Supply caused by Expansionary
Monetary Policy. For simplicity, this can be assumed to be the
printing of currency. Since this money is being created, in
essence, by the government, its issue into the economy in the
form of Money Supply would manifest through Government
Spending, which would, as observed in the previous sections,
cause Aggregate Demand to rise. Herein, we notice that the
Money Demand must increase, at least, by an amount
equivalent to the increase in Money Supply. In Figure 5, we see
a similar situation with the Long-Run Loanable Funds Market.
Herein, however, the Supply is not perfectly inelastic, owing to
the fact that the government is not the sole regulator of loanable
funds, and the existence of actors such as lenders. As we see in
the figure, the situation is similar to what happens with the
Money Market- Supply of Loanable Funds increases due to an increase in funds overall (more money), and the Demand increases
by at least an equal amount due to the GSM. Therefore, this helps us understand better the effects of the underline phenomena on
Money Markets. There does exist and we must concede the possibility of the Demand for both Money and Loanable Funds
growing by more than the Supply, but there exists a stabiliser for these, which is explored further in subsection D of the paper.
(Thomson, Pierce and Parry 1975) (James 1976) (Sauer 2016) (Fuerst 1992)
C
Drawing a parallel between Expansive Supply-Side Monetarism and Government Spending
As has been established previously, monetary policy is enacted by authorities closely related to the government, such as central
banks- for purposes of coordination, one can safely assume. Considering the effects of Expansionary Monetary Policy that leads to
an increase in the Supply of Funds, we must look at how this related to Expansionary Fiscal Policy- focusing on Government
Spending. We see in examples like the purchase of government bonds on the market (Rippy 1950) one way in which money is
injected into the economy, and Supply is increased (Grauwe and Ji 2013). Since, in technicality, this money goes directly into the
hands of bond holders, this can be compared to stimulus or other Government Expenditures, which would also technically go into
the hands of economic actors- directly or indirectly (Gravelle 1998). Hence, we can safely apply the same principles to Monetary
Policy that we do to Government Spending. With a more sophisticated example like printing currency, it is not immediately clear
how that money is used. We should consider here that when currency is printed, it must go either into the federal reserves or be
spent by the government. Herein, we see that the money that goes into the federal reserve above a certain benchmark is, by
definition, meant to be spent by the government eventually or indirectly through its departments- in expenses or in the form of
other, non-centralised implementations (Murphy 2021). In the Long Run, money that goes into the federal reserve must also be
spent- otherwise making null the purpose of printing currency. Hence, it is safe to assume the outlaid conditions for all Expansive
Monetary Policies, meaning that we can apply the GSM principles founded previously to such occurrences. Moreover, as Money
Supply is increased, we must note that the Interest Rate falls- since a higher Money Supply caters to a constant Money Demand.
As the Interest Rate falls, investments and other borrowing becomes more attractive in an economy, and hence investments rise,
causing Aggregate Demand to rise as well. Thereby, increasing the Money Supply through Expansive Supply-Side Monetarism
had the same effects on Aggregate Demand as does Government Spending.
D
The Conflict of Crowing Out
Crowding out occurs in Money Markets when due to Government Spending, Aggregate Demand rises, causing Money Demand to
expand by extension (Furceri and Sousa 2011) (Ganelli 2003) (Buiter 1977). The argument is that the increase in Demand would
cause rise in the rate of interest, thereby offsetting the increase in Demand. This, however, does not occur in a market due to the
main condition of our model, that is that any Government Spending will increase Aggregate Supply at least as much as it will
increase Aggregate Demand. This means that as resources grow in conjunction with the need for them, the overall requirement for
more money to purchase those resources remains stable. Hence, Money Demand does not expand, at least not without a
corresponding expansion in Money Supply. Another issue faced here when dealing with Money Markets with respect to the
outlined conditions is that it is a definite possibility that MD does grow more than MS does, possibly due to a high degree of
stimulation. This, however, is set off by the very conditions of crowding out: as MD grows beyond the previous level of
equilibrium (as it stands at the set rate of interest), it will trigger a negative feedback mechanism that will increase rates of interest
so that a momentary fall in expenditure adjusts it back to the original level, and Demand returns to the old equilibrium. Hence, in
the Long-Run, Money Demand and Money Supply remain synchronised, and the rate of interest remains consistent after
Government Spending and/or Expansionary Monetary Measures.
E
The Creation of Deficits as a result of Expansive Supply-Side Monetarism
There always exists the possibility that instead of simply creating
more money, a government may decide to borrow it from itself, so to
say. Essentially, there is no creation of money, and money is instead
used by increasing the national deficit (public debt). This is a form of
hybrid Monetary-Fiscal policy, since with monetary measures that
include money loaned or spent on purchases or other expansions of
demand, money is technically still used, coordinated as a form of
government spending (Bianchi and Ilut, Monetary/Fiscal policy mix
and agents' beliefs 2017) (Bianchi, Evolving Monetary/Fiscal Policy
Mix in the United States 2012). The issue that arises is the question
of inflation and the effect, if any, that national debt has. Technically,
a national debt has to be paid off over time with interest on it,
however, in practice, there exist no bounds on a nation’s own debt,
due to the lack of incentives for governing bodies to do so (Hargreaves 2013) (Meade 1958). If explored in theory, one can
conclude that a nation’s own capability to lend to itself, or to anyone else for that matter, forms part of the supply of Loanable
Funds in the long run. Herein, we operate on the key assumption that this capability is limited, which is not empirically provable.
This leads us to believe that when a nation borrows from itself, that would form part of the demand for Loanable Funds in the long
run. Hence, if we assume that the supply is limited and thereby fixed, any increases in demand for Loanable Funds would cause a
theoretical increase in the Real Interest Rate, which will increase the real price of taking on debt in the future, which would cause
inflation only in theoretical debt, but not in actuality. However, one can argue that as borrowing becomes more expensive, this has
the same effect that inflation does, at least by extension, since people will not be able to afford to borrow as much and will thereby
have to reduce their borrowed consumption, since they will not be able to afford as much as they previously could, at least after
borrowing. This increase rate of interest, also, would counteract inflation, since an increase in the price of borrowing would
dissuade investment and consumption, and thereby act as a reductive force on Aggregate Demand. Now, we must also explore the
very real possibility that a nation’s ability to create as well as take on debt is not, in fact, limited. We see this as nations around the
world take on and manage to supply themselves with increasing amounts of debt with seemingly little to no restrictions. Here, we
would have to assume that for the government, the Loanable Funds’ supply is unlimited- the quantity supplied and increase and
decrease with almost no pressure. This would actually tend to create a more realistic picture of an extremely, and in practice, a
perfectly- inelastic supply curve for Loanable Funds for the Government in the long run. Thereby, as demand can be increased and
decreased based on levels of spending, the quantity of Loaned Funds will increase with almost no fluctuations in Real Interest
Rate. Figure 6 displays this situation, wherein the Real Interest Rate Elasticity of the Supply of Loanable Funds by and to the
Government in the Long Run is Infinite. Hence, there is no inflation even in Interest Rates.
F
Contrasts with the Ricardo-de Viti-Barro Equivalence Theorem
The Theory of Ricardian Equivalence argues that by spending through the creation of deficits rather than simply crafting more
money, governments make a choice to raise taxes later to pay back the debt created. Essentially, it states that a deficit now is the
same as a tax later, and since it assumes the rationality of consumers within an economy, it also hypothesizes that consumers will
take this into account when spending, and thereby save more money to pay a potentially higher tax in the future. When
considering the theorem alongside the previously proven modelling, we must explore the idea of a debt trap as it applies to
governments internally. Classically, a debt trap occurs when an entity borrows money to pay off a previous debt, thereby creating
another debt which will have a higher interest than the original one. When considered with governments, we see that if a
government ever does decide to pay back its national debts, it may easily fall into a debt trap- that is borrow money from itself to
pay itself back the money that it previously borrowed from itself. Whilst this may seem like a conundrum and potentially harmful
since it increases the level of national debt overall, this has no actual consequence on inflation, since the Interest Rates remain the
same, as displayed in Figure 6. Now, the Theory of Ricardian Equivalence notes that an expenditure out of debt will have a
downward pressure on Aggregate Demand, since it is a tax in technicality. Thereby, extending this theory, we can apply the Tax
Multiplier to the situation. Since the tax multiplier is GSM-1, the overall impact of a borrowed spending on Aggregate Demand,
according to the Ricardian Theory, should ideally be GSM-(GSM-1) multiplied by the Government Spending. Hence, this implies
that the effect is the same as Government Spending, that is that the impact of Borrowed Government Spending on Aggregate
Demand should be equal to the Government Spending itself. When considering this along with the hypotheses underlined in
Section II B, we see that even when Ricardian Equivalence is taken as a mathematical condition to a Borrowed Government
Expenditure, Government Spending does not cause inflation. This happens because of three reasons. Firstly, the Borrowing does
not increase the Rate of Interest; Secondly, the Aggregate Demand will increase just as much as Government Spending will,
whilst the Aggregate Supply will increase by at least an equal amount; and Thirdly because interest paid on previous borrowings
will be subject to the same effect on the Interest Rate, that is no effect, as the initial borrowing (Seater 1993) (Bernheim, Ricardian
Equivalence: An Evaluation of Theory and Evidence 1987) (Ricciuti 2003).
III
Connections to the Equation of Exchange
A
Establishing the Equation, and traditionally Classical and Monetaristic Assumptions
As it relates to us, the equation of exchange creates a relation between several components in an economy, and stems off from
monetary economics. At its very crux lie four components: the Money Supply (M), the Money Velocity (V), the Price Level (P),
and the Real Expenditure or simply Quantity Sold (Q). The Equation Dictates, M*V=P*Q, that is that the Money Supply
multiplied by the Money Velocity must equal the Price Level multiplied by Real Expenditure. It is a traditionally Classical Belief
that the component Q is stable within an economy, and a Monetarist one that the component V is stable within an economy. Since
these components can be equated in any way, at least as the equation argues, we can start to quantify them to give the equation
meaning. The Money Supply is a simple value, and can be quantified in the currency of trade as the total amount of Money in
circulation. The Money Velocity is a component that cannot be given a direct value to, and must be computed indirectly by
equation. The Price Level can be simply found as the Consumer Price Index, or otherwise as Percentage Inflation added to 100%.
The Real Expenditure is the Real Gross Domestic Product. The right side of the equation can also be considered wholly as the
Nominal Gross Domestic Product, since Real Gross Domestic Product is the Nominal Gross Domestic Product divided by the
Consumer Price Index. (Bernheim, Ricardian equivalence: An evaluation of theory and evidence 1987) (Dean 1988) (Sprindt
1985)
B
Component-wise Variations with respect to previously identified rules
We can consider herein that since all components are equated absolutely, so should be their variations. This means that an increase
in the left side of the equation will also lead to an increase in the right side of the equation. Hypothetically, if M would increase
due to Expansive Supply-Side Monetarism by the Government, the product of P and Q should also increase. However, as
established before, we know that an increase in Money Supply will not cause inflation, so only Q will increase, that is the Real
GDP. Since we know that P is constant and only Q variates, the increase in RGDP should be the increase in M multiplied by the
increase in V. Thereby, if Money Supply is increased by a given amount, say ^M, and RGDP increases by ^Q, then the increase in
V should be ^Q/^M. Since we know that increasing either M or V will increase Q, we can rule out the possibility that Q is
constant, thereby contradicting the Classical belief that it is. Moreover, to find V in a given time frame, we can measure the
increase in RGDP and divide it by the increase in Money Supply. Since V=(P*Q)/M, we can also measure the Money Velocity at
any given time, by dividing the Nominal GDP by the Money Supply.
If we consider the Monetarist belief that V is constant, then ^M=^Q, meaning that an increase in Money Supply is going to reflect
in a directly proportional increase in RGDP. This means that as ^Q=^M and ^Q=GSM*^GS, ^M=GSM*^GS. Since the proportion
of Money Supply that is spent by the Government can be defined as (^)GS/(^)M, we can say that the Proportion of the Increased
Money Supply that the Government Spends is equal to 1/GSM. Moreover, as we know that GSM=1/MPS, we can also say that
this proportion equals exactly the Marginal Propensity to Spend in an economy. Thereby, we define the new rule, that assuming
that the Money Velocity remains constant, the Proportion of the (increase in) Money Supply that a Government Spends is equal to
the Proportion of Income that actors in an economy Save.
D
Contrasts with the Quantity Theory of Money (QTM)
The Quantity Theory of Money essentially argues that Money Supply varies directly in proportion to Price Level. Hence, it states
that if M is increased by the government, P will also increase. However, we have disproved this in the past, and defined that on the
right side of the equation, i.e., P*Q, Q will account for the increase, and P will remain constant. This directly conflicts with the
QTM and disproves it. (Macmillan 2018)
IV
Conclusion
Having found convincing proof for the outlined phenomena, we can arrive at five conclusions. Firstly, we see that at least 100% of
Government Spending will contribute to growth in Real Gross Domestic Product. Secondly, we know that increasing the Money
Supply inflates neither the Price Level nor the Rate of Interest within an economy. Thirdly, Government Borrowing of Money
does not influence the rate of interest, since the Real Interest Rate Elasticity of the Supply of Loanable Funds by and to the
Government in the Long Run is Infinite. Fourth, if Ricardian Equivalence is assumed, the impact of Borrowed Government
Spending on Aggregate Demand should be equal to the Government Spending itself. Fifth, Assuming that the Money Velocity
remains constant, the Proportion of the (increase in) Money Supply that a Government Spends is equal to the Proportion of
Income that actors in an economy Save. Limitations of the analysis are that the conclusions depend on parts of certain theories to
disprove themselves internally, and depend heavily on certain diagrammatic representations. Thereby, we define with confidence
that Government Spending (even if financed by National Debt or increases in Money Supply) does not cause inflation.
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