In the long run, the inflation rate equals the level implied by:
A)The rate of money growth
B)Aggregate demand
C)The exchange rate
D)Fiscal policy

Question

Quizplus · Accepted Answer

In the long run, the inflation rate is primarily determined by the rate at which the money supply (or monetary base) grows. This is known as the quantity theory of money. According to this theory, the growth rate of the money supply is directly proportional to the growth rate of prices in the economy. Therefore, if the central bank increases the money supply at a faster rate than the growth rate of real output, the inflation rate will increase in the long run. Conversely, if the central bank reduces the rate of money growth, the inflation rate will fall.

The other options (B) Aggregate demand, (C) The exchange rate, and (D) Fiscal policy may affect the short-run inflation rate, but their impact is less important in the long run. For example, an increase in aggregate demand or a depreciation of the exchange rate may cause a temporary increase in prices, but this effect will dissipate over time as the economy adjusts to the new conditions. Similarly, changes in fiscal policy may have an impact on prices, but they are usually targeted towards addressing other issues like employment or economic growth, rather than controlling inflation directly.

In the Long Run, the Inflation Rate Equals the Level