Question

If velocity is not constant between this year and next, what would happen to the forecasted inflation rate? Specifically, if velocity increases by 2%, what would the true inflation rate be?

a. It would increase.
b. It would decrease.
c. It would remain the same.
d. It is impossible to determine.

Answer 1

If velocity increases by 2%, the inflation rate would likely increase because money would be circulating more quickly throughout the economy, leading to higher spending and potentially an increase in inflation.

Step-by-step explanation:

If the velocity of money increases by 2%, it generally implies that money is circulating through the economy more quickly, which can drive further spending and potentially lead to an increase in the inflation rate. According to the Quantity Theory of Money, if money supply and velocity are constant, changes in the money supply would result in proportional changes in nominal GDP. Therefore, an increase in velocity would likely mean nominal GDP could rise faster than the growth of money supply alone would predict. This could result in a higher portion of the change being reflected as inflation if the actual output of the economy (real GDP) does not grow accordingly. Hence, the answer to the question is a. It would increase.