Under the monetary approach to exchange rate theory, money supply growth at a constant rate
A) eventually results in ongoing price level deflation at the same rate, but changes in this long-run deflation rate do not affect the full-employment output level or the long-run relative prices of goods and services.
B) eventually results in ongoing price level inflation at the same rate, but changes in this long-run inflation rate do affect the full-employment output level and the long-run relative prices of goods and services.
C) eventually results in ongoing price level inflation at the same rate, but changes in this long-run inflation rate do not affect the full-employment output level or the long-run relative prices of goods and services.
D) eventually results in ongoing price level inflation at the same rate, but changes in this long-run inflation rate do not affect the full-employment output level, only the long-run relative prices of goods and services.
E) eventually results in ongoing price level deflation at the same rate, but changes in this long-run deflation rate do not affect the full-employment output level, only the long-run relative prices of goods and services.

Question

Quizplus · Accepted Answer

According to the monetary approach to exchange rate theory, money supply growth at a constant rate eventually results in ongoing price level inflation at the same rate. However, this long-run inflation rate does not affect the full-employment output level or the long-run relative prices of goods and services. This is because the long-run equilibrium exchange rate adjusts to changes in the money supply in such a way that the purchasing power of money is maintained in the long run. Therefore, changes in the inflation rate only affect the nominal exchange rate, not the real exchange rate or the relative prices of goods and services.

Under the Monetary Approach to Exchange Rate Theory, Money Supply