Suppose that real GDP grows by 3 percent a year, the quantity of money grows 5 percent a year, and velocity does not change.In the long run, the inflation rate equals
A) 8 percent.
B) 3 percent.
C) 5 percent.
D) 2 percent.
E) 10 percent.

Question

Quizplus · Accepted Answer

In the long run, the inflation rate can be determined using the equation of exchange: MV = PY. If velocity (V) is constant, the growth rate of money supply (M) minus the growth rate of real GDP (Y) gives the inflation rate. Here, 5% (money growth) - 3% (real GDP growth) = 2% inflation rate.

Suppose That Real GDP Grows by 3 Percent a Year