Suppose monetary neutrality holds and velocity is constant.A 4 percent increase in the money supply
A)increases the price level by more than 4 percent.
B)increases the price level by 4 percent.
C)increases the price level by less than 4 percent.
D)increases real GDP by 4 percent.

Question

Quizplus · Accepted Answer

If monetary neutrality holds and velocity is constant, then the quantity theory of money suggests that a 4 percent increase in the money supply will lead to a 4 percent increase in the price level (MV=PY, where M is the money supply, V is velocity, P is the price level, and Y is real GDP). This is because the increase in money supply is directly proportional to the increase in total spending (MV), assuming that velocity remains constant. Therefore, the increase in spending will be reflected in a proportional increase in prices (P), leaving real GDP (Y) unchanged.

Suppose Monetary Neutrality Holds and Velocity Is Constant