Question

According to the data, output growth in the United States has averaged around 3%, inflation has averaged around 4% for the last 50 years, while money growth has averaged around 7%. What does this say about the growth rate of velocity? If money growth increased to round 10% for the next 50 years, what would you predict inflation to average over the next 50 years? Why?

Answer 1

According to the quantity theory of money, we have:

growth rate of money + growth rate of velocity = growth rate of output + growth rate of prices (inflation)

=> 7 + growth rate of velocity = 3 + 4

=> growth rate of velocity = 0

The velocity has stayed constant for the last 50 years

In the long run (next 50 years) an increase in the growth of money is only going to lead to an increase in prices and not on output. Thus, if money growth increases from 7 to 10%, inflation will also increase from 4 to 7%. This is referred to as the neutrality of money