How is the money supply related to the level of GDP?  Why is it
necessary for this link to behave in a stable and consistent manner in
order for monetary policy to be effective?

Hi maxine-ga,

There is a positive correlation between money supply and the level of
GDP. When money supply increases, this triggers inflation to increase
as well. When inflation increases the price of goods and services
rises because the value of a monetary unit (like a US Dollar) is less.
So if you assume that the GDP in a country is X dollars for, say, the
year 2001:

Consider the year 2002, where rate of inflation is 2% over 2001 (this
essentially means that $1 in 2001 is only worth $0.98 in 2002. If we
assume that the country has had the same level of purchases in both
years, then we can conclude that the GDP has gone up by approximately
the same amount.

Hope that clears things up :)

answerguru-ga