Assume that the velocity does not change over time. If real GDP grows at 1% and money supply at 2%, what is the inflation rate? If your answer is 78.90%, write 78.90
Question
Assume that the velocity does not change over time. If real GDP grows at 1% and money supply at 2%, what is the inflation rate? If your answer is 78.90%, write 78.90
Solution
The inflation rate can be calculated using the Quantity Theory of Money, which is expressed in the equation MV = PY. In this equation, M is the money supply, V is the velocity of money (how fast money changes hands), P is the price level (which relates to inflation), and Y is the real GDP.
Given that the velocity does not change over time (V is constant), and we know the growth rates of M (money supply) and Y (real GDP), we can rearrange the equation to solve for P (price level or inflation).
The growth rate of M (money supply) is 2% and the growth rate of Y (real GDP) is 1%. Therefore, the growth rate of P (price level or inflation) is the growth rate of M minus the growth rate of Y.
So, the inflation rate is 2% - 1% = 1%.
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