Which of the following predictions can be made using the growth rates associated with the equation of exchange, given that velocity is stable and that the economy moves to its potential output (Y_P) in the long run? A) If the money supply grows at a faster rate than growth in Y_P, there will be inflation. B) If the money supply grows at a slower rate than growth in Y_P, there will be a decrease in the inflation rate. C) If the money supply grows at the same rate as growth in Y_P, the price level will fall and there will be deflation. D) If the money supply grows at the same rate as growth in Y_P, the price level will also increase at the same rate as growth in Y_P.

Question

Quizplus · Accepted Answer

The equation of exchange states that MV = PY, where M is the money supply, V is velocity, P is the price level, and Y is real output. Assuming that velocity is stable and the economy is at potential output in the long run, we can simplify the equation to M = PY. If the money supply grows at a faster rate than Y, then P must increase (since Y is at its potential level). This means that there will be inflation. Therefore, choice A is the correct prediction. Choice B is incorrect because a slower growth rate in the money supply would lead to a decrease in inflation, but it would not necessarily cause deflation. Choice C is incorrect because if the money supply grows at the same rate as Y, there will not necessarily be deflation. Finally, choice D is incorrect because it assumes that the money supply and real output will grow at the same rate, which may not always be the case.

Which of the Following Predictions Can Be Made Using the Growth