The rules-based monetary policy reads: The money supply will increase 3 percent each year.If the average annual growth rate in Real GDP is 2 percent and velocity increases by 1 percent each year,it follows that

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The quantity theory of money states that MV = PQ, where M is the money supply, V is velocity, P is the price level, and Q is real GDP. If the money supply increases by 3 percent each year, velocity increases by 1 percent each year, and real GDP increases by 2 percent each year, then the price level must increase by 2 percent each year in order for the equation to hold.

The Rules-Based Monetary Policy Reads: the Money Supply Will Increase