Question

Suppose a constant-money-growth-rate rule of 3 percent is being considered. If it is estimated that average annual Real GDP growth is 3.5 percent and it turns out that velocity is rising by 2 percent a year on average, the rule would produce an average annual rate of inflation of __________ percent.

Answer 1

Answer:

annual rate of inflation: 1.5%

Explanation:

The quantitative theory of money (QTM) states that MV=PT

M=money supply

V=money velocity

P=price level

T=number of transactions or GDP (Y)

We want to find the equation above in terms of rate of change because the problem says money "growth-rate" velocity is "rising" and GDP "growth". So the transformed equation is:

ΔM+ΔV=ΔP+ΔY.  

The problem is asking for the ΔP:

ΔP=ΔM+ΔV-ΔY

ΔP= 3%+2%-3.5%

ΔP= 1.5%