Consider an economy where the growth rate of real GDP is 6 percent and the annual rate of inflation is 2 percent.If the quantity theory of money holds,the growth rate of money supply in the economy will be ________.
A) 2 percent
B) 4 percent
C) 6 percent
D) 8 percent

Question

Quizplus · Accepted Answer

According to the quantity theory of money, MV = PY, where M is the money supply, V is velocity of money, P is the overall price level, and Y is real GDP. Assuming velocity of money and overall price level remain constant, we can rearrange this equation to get M = (PY) / V.

Therefore, if the growth rate of real GDP is 6 percent and the annual rate of inflation is 2 percent, then the growth rate of nominal GDP (PY) will be 8 percent (6% real GDP growth + 2% inflation). If we assume that velocity of money remains constant in the short run, the growth rate of money supply (M) must also be 8 percent to maintain this equilibrium, hence the correct answer is D) 8 percent.

Consider an Economy Where the Growth Rate of Real GDP