Using the equation of exchange, if inflation is 1.5%, real output grows by 3.0%, and the growth rate of money is 5.0%, the change in the velocity of money is:

Question

Quizplus · Accepted Answer

The equation of exchange is MV = PQ, where M is the money supply, V is the velocity of money, P is the price level (inflation), and Q is the real output. The growth rates of these variables add up, so if inflation (P) is 1.5%, real output (Q) grows by 3.0%, and the growth rate of money (M) is 5.0%, then the change in the velocity of money (V) must balance the equation. 5.0% (M) + X% (V) = 1.5% (P) + 3.0% (Q). Solving for X gives X = -0.5%, meaning the velocity of money decreases by 0.5%.

Using the Equation of Exchange, If Inflation Is 1