Question

Suppose the full-employment level of real GDP is increasing at a rate of 3% per period and the money supply is growing at a 4% rate. What will happen to the long-run inflation rate, assuming constant velocity?

Answer 1

The formula is:-

MV=PY

where M=money supply

V=velocity

P=price level

Y = real GDP

Assuming constant velocity

1.04MV=1.03PY

P = 1.04/1.03

P = 1.00970

So, inflation rate will be 0.97% or 1%