If the money supply is growing at 8%, the real rate of growth of GDP is 2%, and financial
innovations are reducing the demand for money by 0.5% per year, what should the long-run
inflation rate be?
Solution
According to the quantity theory of money:
Money supply (M) x Velocity of money (V) = Price level (P) x Real GDP (Y)
So,
Change in M + Change in V = Change in P (Inflation rate) + Change in Y
Here,
8% - 0.5%** = Inflation Rate + 2%
Inflation rate = (8 - 0.5 - 2)% = 5.5%
** If demand for money reduces by 0.5%, it means that transacitons velocity of money reduces
by the same percentage. So, change in V = - 0.5%.
This PowerPoint helps students to consider the concept of infinity.
If the money supply is growing at 8, the real rate of growth of GDP.pdf
1. If the money supply is growing at 8%, the real rate of growth of GDP is 2%, and financial
innovations are reducing the demand for money by 0.5% per year, what should the long-run
inflation rate be?
Solution
According to the quantity theory of money:
Money supply (M) x Velocity of money (V) = Price level (P) x Real GDP (Y)
So,
Change in M + Change in V = Change in P (Inflation rate) + Change in Y
Here,
8% - 0.5%** = Inflation Rate + 2%
Inflation rate = (8 - 0.5 - 2)% = 5.5%
** If demand for money reduces by 0.5%, it means that transacitons velocity of money reduces
by the same percentage. So, change in V = - 0.5%
