Making use of Okun's law, if the Bank of Canada reduces the money supply 5 percent and the quantity theory of money is true, then the unemployment rate will rise about:
A)5 percent in both the short run and the long run.
B)1.66 percent in both the short run and the long run.
C)5 percent in the short run, but will return to its natural rate in the long run.
D)1.66 percent in the short run, but will return to its natural rate in the long run.

Question

Quizplus · Accepted Answer

According to Okun's law, a 1% decrease in GDP results in a 0.5% increase in unemployment. A 5% reduction in money supply would reduce GDP by 5%, increasing unemployment by 2.5%. However, the quantity theory of money suggests prices adjust in the long run, so unemployment returns to its natural rate.

Making Use of Okun's Law, If the Bank of Canada