Mark Brandly asks this morning what might have happened to the price level if the money supply was fixed in 1959 at the 1959 level.

Expansionary monetary policies drive prices up. However, if the money supply was fixed, prices would tend to fall. Any potential decrease in the price level is ignored by the CPI and by price indices in general. To estimate the total price effect of expansionary monetary policies, we must also consider the potential decrease in the price level that would have occurred in the absence of such monetary policies.

The value of money and therefore the price level is determined by the supply and demand for money. As the economy grows, the demand for money tends to increase, driving the value of money up and the price level down. Historically, when economic growth is accompanied by increases in the money supply, the inflationary effects on prices due to the monetary expansion have generally outweighed the economic growth's negative effects on prices.

The price level increases, but economic growth reduces the amount of the rise of the price level. If there was no real economic growth, then monetary policies would result in even higher prices. The total effect on the price level due to monetary policies includes the increase in the price level due to an expanding money supply and the potential decrease in the price level that would have occurred in the absence of expansionary monetary policies.