Question

Assume an economy’s annual money velocity in circulation is 10. Please answer the following two questions:

1. If the annual nominal GDP is $20 trillion, how much money supply are enough for money demand?
2. In the view of monetarists (i.e. neoclassical view), if the annual economic growth rate is 5%, what should be the money supply increasing rate to maintain a low inflation rate as 2%?

Answer 1

Solution :-

Given Data and representation in short from :

Money supply = M

Velocity = V = 10

Price level = P

Real GDP = Y

Nominal GDP = P×Y = $20 trillion

Answer (a) :-

As we know that ;

M = (P×Y)/V = $20 trillion/10 = $2 trillion

Hence the money supply (M) will be $2 trillion.

Answer (b)

We also know that that ;

(%M) + (%V) = (%P) + (%Y)

Since, Since velocity is constant therefore

%V = 0

%M = 2% + 5% = 7%

Thus, in order to maintain 2% inflation, money supply (M) must need to grow more than 7%