If velocity and output were nearly constant, how would the inflation rate compare with the money supply growth rate?
A)The inflation rate would be much higher than the money supply growth rate.
B)The inflation rate would be about the same as the money supply growth rate.
C)The inflation rate would be much lower than the money supply growth rate.
D)The inflation rate cannot be compared with the money supply growth rate because they are independent of each other.

Question

Quizplus · Accepted Answer

According to the quantity theory of money, MV = PQ, where M is the money supply, V is the velocity of money, P is the price level, and Q is the quantity of output. If we assume that the output is nearly constant and the velocity of money is also nearly constant, then we can say that MV is nearly constant. This means that any increase in the money supply (M) will lead to an increase in the price level (P). Therefore, the inflation rate (percentage change in P) would be roughly equal to the growth rate of the money supply (percentage change in M). Hence, the inflation rate would be about the same as the money supply growth rate.

If Velocity and Output Were Nearly Constant, How Would the Inflation