Which of the following predictions can be made using the growth rates associated with the equation of exchange, given that velocity is stable and that the economy moves to its potential output (Y_P) in the long run? A) If %∆M = %∆ Y_P , then %∆P = %∆M. B) If %∆M %∆ Y_P , then %∆P 0. C) If %∆M %∆ Y_P , then %∆P %∆M. D) If %∆M = %∆ Y_P , then %∆P

Question

Which of the following predictions can be made using the growth rates associated with the equation of exchange, given that velocity is stable and that the economy moves to its potential output (Y_P) in the long run? A) If %∆M = %∆ Y_P , then %∆P = %∆M. B) If %∆M > %∆ Y_P , then %∆P > 0. C) If %∆M > %∆ Y_P , then %∆P > %∆M. D) If %∆M = %∆ Y_P , then %∆P < 0.

Quizplus · Accepted Answer

According to the equation of exchange, MV = PY, where M is the money supply, V is velocity, P is the price level, and Y is the real output. Assuming velocity is stable, if the economy moves to its potential output in the long run, then Y is equal to Y_P. Therefore, we can rewrite the equation of exchange as %∆M + %∆V = %∆P + %∆Y_P. Since velocity is assumed to be stable, %∆V equals zero. Therefore, %∆P is equal to %∆M minus %∆Y_P. This means that if %∆M is greater than %∆Y_P, then %∆P is positive, indicating inflation. Hence, the correct prediction is B: If %∆M > %∆ Y_P , then %∆P > 0.

Which of the Following Predictions Can Be Made Using the Growth