Question

1-) In the following question, you are asked to determine whether the statements are true or false. Explain your reasoning to get full credit:

c) Assume velocity is constant. Suppose Fed wants to follow a zero-inflation policy. Then, the rate of money growth should be kept equal to zero by the Fed.

Answer 1

False.

The answer can be justified on the basis of quantity theory of money. If velocity is constant, it indicates that the growth rate of velocity is zero. Velocity doesn't change due to external or internal factors in the economy.In such a situation, growth rate in money supply will be exactly equal to the rate of inflation added to growth rate of real GDP. Here inflation target is zero , so inflationary rate is zero. But the growth rate of real GDO won't be zero . So growth rate of money supply won't be zero.

Now let's look at it from different point of view, when velocity is constant, the growth rate in inflation will be the difference between growth rate of money supply and growing rate output. Here inflation is targeted to be zero. In order to make it happen , growth rate in Money supply should exactly be equal to the growth rate in output not zero.