Question

It is sometimes suggested that the Federal Reserve should try to achieve zero inflation. If we assume that velocity is constant, does this zero-inflation goal require that the rate of money growth equal zero?

If yes, explain why. If no, explain what the rate of money growth should equal.

Answer 1

The correct answer is False.

Step-by-step explanation:

The quantitative theory of money is an economic theory that aims to explain the causes of inflation, that is, the variations in prices and the value of money in a country.

To explain inflation, the quantitative theory of money relates the money supply to the general price level. The money supply is the amount of money that exists in the economy. It can be estimated since it is the central banks that control the liquidity of the economy.

If we take into account a quantitative equation, which relates the amount of money (M) to the nominal value of production (P × Y) as follows: M × V = P × Y. With constant speed, reduce the rate of inflation to zero (constant P) would require that the variables M and Y be proportionally related. Therefore, the growth rate of money must be equal to the growth rate of the real product.