The latest estimate of inflation for the past year is approximately 8.6%. This rate of inflation is the highest since the early 1970's. I remember it well. There is a debate of the cause for the current inflation. The debate emphasizes the cause as a "Supply Shock" or a "Demand Shock." Please answer the following questions using Aggregate Demand (AD) and Aggregate Supply (AS)

a. Define inflation and explain two of the indices used to measure inflation.

b. What did Milton Friedman mean when he stated "Inflation is always and everywhere a monetary

phenomenon,..."?

c. How does Friedman's statement relate to the Quantity Theory of Money? The Quantity Theory statement takes the following form: %P = %M + %V - %Y

d. There have been two important explanations for the current rate of inflation (): A Supply Shock and a Demand Shock. President Biden has in a recent speech said "What people don't know is that 70 percent of the increase in inflation was the consequence of Putin's price hike because of the impact on oil prices. Seventy percent." President Biden, remarks at the North Carolina Agricultural and Technical State University in Greensboro, N.C., April 14. President Biden has also blamed the Supply Chain issue and Covid-19 as causes for the current inflation.

These statements are consistent with a "Supply Shock" as the cause for inflation. Using AD/AS graphical analysis with inflation () measure on the vertical axis and real production (real GDP) on the horizontal axis explain what a Supply Shock is as a cause of inflation.

Then explain in detail how the Federal Reserve's monetary policy can be used to reduce inflationary forces and inflation itself. What will be the effect on real production (Real GDP)?

e. Another argument for inflation is from a "Demand Shock." This argument is based on the quantity theory of money and Milton Friedman's statement above. The Demand Shock argument is based on the Fed policy of quantitative easing and, more recently, the Covid-19 relief program in both the Trump and Biden administrations. These relief programs came in the form of "fiscal policy" financed by the Federal Reserve purchasing treasury securities by printing money (monetization of Treasury debt).

Using AD/AS graphical analysis explain what a demand shock is and how the recent monetary and fiscal policies caused inflation.

Then explain in detail how the Federal Reserve's monetary policy can be used to reduce inflationary forces and inflation itself. What is the effect of this monetary policy on real production (Real GDP)?

e. Which explanation do you believe is the cause for the current inflation? Explain why.