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6 December, 14:05

According to the quantity theory of money, if the longminusrun economic growth rate is 2.5%, by how much should the Fed increase the money supply if it wants inflation to be 2%?

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  1. 6 December, 16:10
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    4.5%

    Explanation:

    The quantity theory of money states: M x V = P x Y [M: Money supply, V: Velocity of money, P: price level & Y: GDP or output.

    If the Fed wants inflation to be 2%, it will need to increase the money supply 4.5%.

    Thus M * V will rise 4.5%, causing P * Y to rise 4.5%, with a 2% increase in prices and

    a 2.5% rise in real GDP.
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