Question

According to the quantity theory of​ money, if the longminusrun economic growth rate is​ 2.5%, by how much should the Fed increase the money supply if it wants inflation to be​ 2%?

Answer 1

4.5%

Step-by-step explanation:

The quantity theory of money states: M x V = P x Y [M: Money supply, V: Velocity of money, P: price level & Y: GDP or output.

If the Fed wants inflation to be 2%, it will need to increase the money supply 4.5%.

Thus M × V will rise 4.5%, causing P × Y to rise 4.5%, with a 2% increase in prices and

a 2.5% rise in real GDP.