Suppose that rising productivity increases potential output in each period by 4%. Using the equation of exchange, what kind of monetary policy would be needed to maintain a zero rate of inflation at full employment?
A) It should keep money supply constant.
B) It should increase money supply by 4% per period.
C) It should increase money supply by 4% in the first period and thereafter, hold money supply constant.
D) It should decrease money supply by 4% each period.

Question

Quizplus · Accepted Answer

To maintain a zero rate of inflation at full employment, the money supply should increase at the same rate as potential output, which is 4% per period, according to the equation of exchange (MV=PY).

Suppose That Rising Productivity Increases Potential Output in Each Period