Suppose that a rules-based monetary policy proposal specifies that the money supply will grow 3 percent each year.If velocity grows 1 percent this year and Real GDP grows 2 percent,the price level will __________ by __________ percent.

Question

Quizplus · Accepted Answer

According to the quantity theory of money, MV=PY, where M is the money supply, V is velocity, P is the price level, and Y is real GDP. If the money supply grows 3%, then we have M’=1.03M. If velocity grows 1%, then we have V’=1.01V. If real GDP grows 2%, then we have Y’=1.02Y. The equation becomes (1.03M)(1.01V)=(P)(1.02Y), or M’V’=PY’. Solving for P, we get P=(M’V’)/Y’. Plugging in the values, we have P=(1.03M)(1.01V)/(1.02Y)=(1.0403/1.02)P, which simplifies to P=1.0196P. Therefore, the price level will rise by approximately 2%.

Suppose That a Rules-Based Monetary Policy Proposal Specifies That the Money