Suppose velocity is constant, the growth rate of real GDP is 3% per year, and th

Question

Suppose velocity is constant, the growth rate of real GDP is 3% per year, and the growth rate of money is 5% per year. Calculate the long- run rate of inflation according to the quantity theory in each of the following cases:

a) What is the rate of inflation in this baseline case?
b) Suppose the growth rate of money rises to 10% per year.
c) Suppose the growth rate of money rises to 100% per year.
d) Back to the baseline case, suppose real GDP growth rises to 5% per year.
e) What if real GDP growth falls to 2% per year?
f) Return to the baseline case and suppose the velocity of money rises at 1% per year. What happens to inflation in this case? Why might velocity change in this fashion?

Explanation / Answer

Money supply growth = GDP growth + inflation inflation = Money supply growth - GDP growth A) 5 - 3 = 2. Inflation is 2% B) 10 - 3 = 7 C) 100 - 3 = 97 D) 5 - 5 = 0 E) 5 - 2 = 3 F) Inflation = money supply growth + velocity change - GDP Growth Inflation = 5 + 1 - 3 = 3 Inflation will be 3%

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