2. Suppose that in the U.S., the income velocity of money (V) is constant. Suppose, too,...

2. Suppose that in the U.S., the income velocity of money (V) is constant. Suppose, too, that every year, real GDP grows by 2.5 percent (%∆Y/year = 0.025) and the supply of money grows by 10 percent (%∆M/year = 0.10).

a. According to the Quantity Theory of Money, what would be the growth rate of nominal GDP = P×Y? Hint: %∆(X×Y)  %∆X + %∆Y.

b. In that case, what would be the inflation rate (i.e. %∆P/year)?

c. If the central bank wants the inflation rate to be 0%, what money supply growth rate (i.e. - %∆M per year) should it set?

Expert Solution

a) According to the Quantity Theory of Money, the growth rate of nominal GDP will be 40%.

b) The inflation rate will be 16%.

c)If the Central Bank wants the inflation rate to be 0%, then the growth rate of the nominal money supply must be equal to the growth rate of money demand.

Rahul Sunny answered 2 years ago

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