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IAI Actuarial Core Principles · Business Economics · Recent macroeconomic history

Money supply grows at 9% a year, real output grows at 3% a year, and velocity of circulation is falling at 2% a year. Using the growth form of the quantity equation (approximately %ΔM + %ΔV = %ΔP + %ΔT), what is the implied inflation rate, and what does this show about the monetarist case?

Implied inflation is about 4%, found as 9% money growth minus 2% velocity fall minus 3% output growth. Because velocity is not stable, inflation is below the 6% that money growth in excess of output would suggest, weakening the simple monetarist link and money targeting.

  1. A6%; velocity changes do not matter for the monetarist link
  2. B4%; unstable velocity weakens a simple link between money growth and inflationCorrect
  3. C4%; velocity changes confirm the link is exact
  4. D12%; falling velocity adds to inflation
  5. 8%; output growth is ignored

Explanation

%ΔP = %ΔM + %ΔV − %ΔT = 9 − 2 − 3 = 4%. Without the velocity fall inflation would be 6%, so the unstable velocity breaks the one-for-one relation between money growth excess and inflation, a key criticism of monetarist targeting in the 1980s. Check: 9 − 2 = 7 = 4 + 3.

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