If Real GDP increases at an annual rate of 4 percent and velocity increases at a rate of 1 percent per year,then rules-based monetary policy advocates who wish to maintain a stable price level would set the annual money supply growth rate at
A) 1
B) 2
C) 3
D) 4
E) 6

Question

Quizplus · Accepted Answer

According to the Quantity Theory of Money, MV = PY, where M is the money supply, V is the velocity of money, P is the price level, and Y is the real GDP. To maintain a stable price level (P constant), the growth rate of the money supply (M) plus the growth rate of velocity (V) should equal the growth rate of real GDP (Y). Given that real GDP (Y) grows at 4% and velocity (V) grows at 1%, the money supply (M) should grow at 3% to maintain a stable price level.

If Real GDP Increases at an Annual Rate of 4