Suppose the velocity of money is not fixed, but stable at about two percent growth per year
How could the quantity theory of money be modified to include a stable growth rate of the velocity of money? In this modified quantity theory of money with velocity growing at two percent per year, what would the growth rate of the other variables in the theory need to be to cause inflation?
The quantity theory of money would have to include a growth rate for the velocity of money of about two percent, instead of zero percent. The inflation rate would then be determined by the following equation:
Inflation rate = Growth rate of the money supply + Growth rate of the velocity of money - Growth rate of real GDP.
Inflation would occur if the growth rate of the money supply plus the two percent growth rate of the velocity of money exceeds the growth rate of real GDP. In other words, the growth rate of the money supply must be two percent less than the growth rate of real GDP, or inflation will occur.
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