Suppose the money growth rate is 3 percent, velocity is constant, and real GDP is growing at 2 percent. What is the inflation rate?

Question

Quizplus · Accepted Answer

The equation of exchange is MV = PQ, where M is the money supply, V is velocity, P is the price level, and Q is real GDP. Given that V is constant and Q is growing at 2 percent, we can solve for the inflation rate as follows:

Inflation rate = (P2 - P1) / P1 = (MV2/Q2 - MV1/Q1) / MV1/Q1 = (M/Q)(V2/V1 - 1)
= (3%/2%)(1 - 1) = 1%

Therefore, the inflation rate is 1 percent. Choice B is the correct answer.

Suppose the Money Growth Rate Is 3 Percent, Velocity Is