IAI Actuarial Core Principles · Business Economics · Role of money and interest rates in the economy
A central bank targets inflation using a strict monetarist rule. Money supply growth is held at 10%, and real output is expected to grow at 5%. Velocity unexpectedly falls by 3% over the year. What is the approximate inflation rate?
Inflation is about 2%. Money growth of 10% less the 3% fall in velocity less 5% real output growth leaves 2%. This shows a strict money-growth rule can miss the inflation target when velocity is unstable.
- A12%
- B8%
- C2%Correct
- D5%
- 18%
Explanation
%ΔP = %ΔM + %ΔV - %ΔY = 10 - 3 - 5 = 2%. Ignoring the velocity fall gives 5%. Adding velocity as +3 gives 8%. The result shows that unstable velocity undermines the rule.
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