If the central bank follows a rules-based approach to monetary policy and the velocity of money turns out to be smaller than expected, then inflation:
A) will be lower than expected.
B) will be higher than expected.
C) will be unaffected.
D) could be higher or lower than expected.

Question

Quizplus · Accepted Answer

If the velocity of money turns out to be smaller than expected and the central bank follows a rules-based approach, then inflation will be lower than expected. This is because the rules-based approach typically relies on a fixed relationship between the money supply and inflation, so a lower velocity of money means that the money supply is not circulating as quickly and therefore is not exerting as much upward pressure on prices.

If the Central Bank Follows a Rules-Based Approach to Monetary