Suppose velocity increases by 2 percent and potential GDP grows by 2 percent. The trend inflation rate will equal zero if the quantity of money grows by
A) 0 percent.
B) 2 percent.
C) 4 percent.
D) -2 percent.

Question

Quizplus · Accepted Answer

If velocity and potential GDP grow by the same rate, there is no need for a change in the quantity of money to maintain a zero inflation rate. Therefore, if velocity and potential GDP both grow by 2 percent, the quantity of money should remain unchanged at 0 percent to keep the trend inflation rate at zero.

Suppose Velocity Increases by 2 Percent and Potential GDP Grows