Question

Suppose the money supply has been growing at 10% per year, and GDP has been growing at 20% per year. What can you conclude about the growth rate of inflation?

Answer 1

Change in money supply (?M) + Change in the velocity of money (?V) = Change in prices (?P) + Change in real GDP (?Y)

Here, ?M = 10%

?Y = 20%

We have no information about the change in the velocity of money (?V). If there is no change in the velocity of money i.e. ?V = 0. Then,

?M + ?V =?P+ ?Y

or, 10% + 0% = ?P +20%

?P = 10% - 20% = -10% i.e. there is a deflation of 10%We

We can conclude that:

If the velocity of money is less than 10%, ?P is negative and there is deflation.

If the velocity of money is equal to 10%, ?P is 0 and there is no change in price

If the velocity of money is greater than 10%, ?P is positive and there is inflation.