Using the equation of exchange,the existence of a natural rate of unemployment implies that in the long run:
A)Velocity in the equation of exchange is actually very unstable.
B)Monetary policy affects only the rate of inflation.
C)Quantity of real output in the equation of exchange varies in proportion to money supply.
D)The rate of unemployment can be permanently reduced by more expansionary monetary and fiscal policies.

Question

Quizplus · Accepted Answer

The equation of exchange states that the quantity of money multiplied by velocity equals the price level multiplied by real output (MV = PQ). In the long run, the quantity of real output is determined by factors such as technology, capital stock, and labor force, and is not affected by monetary policy. Therefore, the only way for changes in the money supply to affect the economy in the long run is through changes in the price level, which implies that monetary policy affects only the rate of inflation. The existence of a natural rate of unemployment, which is the rate at which the economy is producing its potential output, does not imply that more expansionary monetary and fiscal policies can permanently reduce the rate of unemployment.

Using the Equation of Exchange,the Existence of a Natural Rate