Question

3. Problems and Applications Q3 ch 30

It is sometimes suggested that the Federal Reserve should try to achieve zero inflation. Assume that velocity is constant.

True or False: In order to achieve this zero-inflation goal, the rate of money growth must equal velocity.

True

False

Answer 1

False.

Explanation: Following is the relationship among money growth (?M), change in the velocity of money (?V), change in prices (?P), and a change in real GDP (?Y):

?M + ?V = ?P + ?Y

So, if velocity is constant i.e. ?V = 0 and we want to achieve zero inflation i.e. ?P = 0, in that case, putting the values, we get:

?M + 0 = 0 + ?Y

or, ?M = ?Y

Therefore, in order to achieve zero inflation, the rate of money growth should be equal to the change in the real GDP.