If real GDP grows by 3 percent, the velocity of circulation does not change, and the quantity of money grows by 3 percent, then in the long run the inflation rate is
A) 3 percent.
B) 0 percent.
C) -3 percent.
D) -6 percent.
E) 6 percent.

Question

Quizplus · Accepted Answer

According to the quantity theory of money, the equation of exchange is MV = PY, where M is the money supply, V is the velocity of circulation, P is the price level, and Y is real GDP. Assuming that V is constant, a 3 percent growth in real GDP (Y) coupled with a 3 percent growth in the money supply (M) will result in no change in the price level (P) or inflation rate. Therefore, the answer is B) 0 percent.

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