Question

The equation of exchange states that the product of the quantity of money, M, and the velocity of money, V, equals the product of the price level, P, and the quantity of real output, Q:

??=??

Because the percentage change in the product of two variables is approximately equal to the sum of the percentage changes in the variables, the equation of exchange can be written in growth rate form as

%Δ?+%Δ?=%Δ?+%Δ?

where %Δ means "percentage change in."

a. Suppose the central bank, following monetarist prescription, wants to set a money growth rule—a rule whereby the central bank increases the money supply by a fixed percentage each year. It has concluded that the velocity of M2 is steady at 2—i.e., a unit of currency exchanges for domestically-produced goods and services 2 times per year on average—and that real output Q will grow on average by 3% per year over the long term. If the central bank's target inflation rate is 2%, it would set a money growth rule of

The equation of exchange states that the product of the quantity of money, M, and the velocity of money, V, equals the product of the price level, P, and the quantity of real output, Q Because the percentage change in the product of two variables is approximately equal to the sum of the percentage changes in the variables, the equation of exchange can be written in growth rate form as where %Δ means "percentage change in." a. Suppose the central bank, following monetarist prescription, wants to set a money growth rule-a rule whereby the central bank increases the money supply by a fixed percentage each year. It has concluded that the velocity of M2 is steady at 2 i.e., a unit of currency exchanges for domestically-produced goods and services 2 times per year on average and that real output Q will grow on average by 3% per year over the long term. Tf the central bank's target inflation rate is 2%, it would set a money growth rule of 4% 1% 3% 0% 5% b. Suppose that in the fol ear, velocity unexpectedly rises to 2.1. All else equal, the inflation rate will be 1% 3% 5% 3% 7%

Answer 1

A)We know from Quantity theory of money

growth rate of M + growth rate of Velocity=Growth rate of P + Growth rate of Y

Thus growth rate of M +0=2+3=5

Thus money growth rate should be 5%

b)If velocity increases from 2 to 2.1 i.e. % change in price=0.1/2*100=5%

Thus growth rate of M+V=P+Y

5+5=growth rate of price+3

Thus growth rate in price/inflation=10-3=7%

Thus ans is E