Fill in the blanks for this situation, shown in the following figure. Suppose th

Question

Fill in the blanks for this situation, shown in the following figure. Suppose that inflation is running at 10% and the central banker would like to lower inflation to 2% without reducing real growth. The central banker should tell the public that the goal is an inflation rate of 2% and the money growth at a rate of ____%. The central banker knows that velocity growth is 0% and that the potential growth rate is 3%.

2% 3% 4% 5% Old LRAS Inflation rate SRAS(Er = 1096) AD (M+ v= 13%) 3% Real GDP growth rate

Explanation / Answer

The correct choice is 5%.

Note that the growth rate of inflation in addition to the growth rate of real GDP makes up the total spending growth. With the growth of GDP fixed at 3%, a target of inflation of 2% employees that total spending growth should be 5%.

With velocity increasing at 0% the money supply should grow at the rate of total spending growth which is 5%. Hence the correct option is 5%.

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