Question

Suppose that a rules-based monetary policy proposal specifies that the money supply will grow 5 percent each year. If velocity grows 2 percent this year and Real GDP grows 2 percent, the price level will __________ by __________ percent.

Answer 1

grow by 5 percent

Step-by-step explanation:

The quantitative theory of money (QTM) states that MV=PT (M=money supply, V=money velocity, P=price level, T=number of transactions). But normally we fin it like this: MV=PY, because the cuantitative equation assumes that the value of transactions is equal to the GDP (Y).

We want to find the equation above in terms of rate of change because the problem says money supply "grows" velocity"grows" and GDP "grows", which means we have minimum two periods of time. So, the transformed equation is: ΔM+ΔV=ΔP+ΔY.

The problem is asking for the ΔP:

ΔP=ΔM+ΔV-ΔY

ΔP= 5%+2%-2%

ΔP= 5% (It is positive, then it is growing)