Inflation - End of Chapter Problem During World War II, both Germany and England had plans for a paper weapon: they each printed the other's currency, with the intention of dropping large quantities by airplane, so as to increase the other's money supply. Select all of the following reasons that might have made this an effective weapon.

a. Relative prices would become more variable.

b. Menu and shoeleather costs would rise.

c. Support for the opposing country would rise.

d. Hyperinflation could undermine the public's confidence in the economy.

e. The banking system would fail.

f. It would create additional seigniorage revenue for the country.

dropping large quantities by airplane, so as to increase the other's money supply will result in the following:

c. Support for the opposing country would rise.

d. Hyperinflation could undermine the public's confidence in the economy.

e. The banking system would fail.

f. It would create additional seigniorage revenue for the country.

Explanation:

When the citizens have access to a opposing country's currency, they will pay allegiance to them. Excess money in circulation will quickly erodes the real value of the local currency, as the prices of all goods increase causing hyperinflation. When the central bank does not control the money in circulation with monetary policies as a result of excess cash in circulation, banks will fail. The cost of printing money notes would create additional seigniorage revenue for the country which will come back to bite.

The correct answer is option 1 [relative prices would become more variable], option 3 [Menu and shoeleather costs would rise], option 4 [Hyperinflation could undermine the public's confidence in the economy].

Explanation:

This is because Dropping of large quantities of currency will increase the currency in circulation in significant manner.

This will bring considerable increase in the money supply in the economy.

When money supply increases, inflation also increase.

So, considerable increase in money supply will lead to hyperinflation in the economy.

This will lead to following consequences -

1. The relative price of goods and services in the economy would become more variable.

2. There would be increase in menu cost and shoe leather cost.

3. Hyperinflation will erode the purchasing power of the people and thus their trust in the country's economy will diminish significantly.