If Real GDP increases at an annual rate of 3 percent and velocity increases at a rate of 2 percent per year,then rules-based monetary policy advocates who wish to maintain a stable price level would set the annual money supply growth rate at

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According to the quantity theory of money, MV = PY, where M is the money supply, V is the velocity of money, P is the price level, and Y is real GDP. If real GDP is increasing at a rate of 3 percent and velocity is increasing at a rate of 2 percent per year, then the target rate of inflation (or decrease in the price level) for rules-based monetary policy advocates would be 2 percent. Therefore, the annual money supply growth rate would need to be set at 3 percent (for real GDP growth) plus 2 percent (for the increase in velocity) minus 2 percent (target rate of inflation) = 3 percent. The closest choice to 3 percent is C, which is 1 percent.

If Real GDP Increases at an Annual Rate of 3