If real GDP grows by 3 percent, the velocity of circulation grows by -4 percent, and the quantity of
Money grows by 3 percent, then in the long run the inflation rate is
A)-4 percent.
B)-1 percent.
C)4 percent.
D)10 percent.
E)1 percent.

Question

Quizplus · Accepted Answer

The equation of exchange is MV = PY, where M is the money supply, V is the velocity of money, P is the price level, and Y is real GDP. In percentage terms, the growth rate of M plus the growth rate of V equals the growth rate of P (inflation rate) plus the growth rate of Y. Here, 3% (M) - 4% (V) = Inflation rate + 3% (Y). Solving gives an inflation rate of -1%.

If Real GDP Grows by 3 Percent, the Velocity of Circulation