If the money growth is 7% a year, the growth of real output is 3% a year, and velocity is constant, then the rate of growth of prices is 10%.

Question

Quizplus · Accepted Answer

According to the quantity theory of money, MV=PQ, where M is money supply, V is velocity, P is price level, and Q is real output. Rearranging this equation, we get P=MV/Q. If we assume velocity is constant and real output is growing at 3% a year, then the rate of growth of prices will be equal to the rate of growth of money supply (7%) minus the rate of growth of real output (3%), which is 4%. Therefore, the rate of growth of prices is 4%, not 10%.

If the Money Growth Is 7% a Year, the Growth