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Knowing that the Colombian economy is $309bn, this discovery is about 5.5% of the Columbian economy....

Knowing that the Colombian economy is $309bn, this discovery is about 5.5% of the Columbian economy. What is the inflation rate that could happen if the Colombian government would increase the money supply by 5.5% to accommodate the discovery of the gold while the average growth rate of the Colombian economy is 2%?

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Answer #1

As per the Quantity equation,

M x V = P x Y, here M: Money supply, V: Velocity, P: Price level, Y: Real GDP

% Change in M + % Change in V = % Change in P (inflation) + % Change in Y (growth rate indicator)

Assuming velocity remains constant in short run, % Change in V = 0. So,

5.5% + 0 = % Change in P (Inflation) + 2%

5.5% = Inflation + 2%

Inflation = 3.5%

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