Suppose the money growth rate is 3 percent, velocity is constant, and real GDP is growing at 2 percent. What is the inflation rate?
A) 6 percent
B) 3 percent
C) 1 percent
D) 5 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. Assuming velocity is constant, %ΔM + %ΔV = %ΔP + %ΔY. Plugging in the numbers, we get 3% (money growth rate) + 0% (assuming constant velocity) = %ΔP + 2% (real GDP growth rate). Solving for %ΔP, we get 1%. Therefore, the inflation rate is 1%.

Suppose the Money Growth Rate Is 3 Percent, Velocity Is