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The Brazilian economy is growing at a 6% annual rate in real terms. The Bank of Brazil is expanding its monetary base (e.g., money M1) at a rate of 30% per year. The Brazilian government bonds yield 26%. What prediction would a monetary economist make for the inflation rate if she believes in quantity theory of money and assumes that the velocity of money is stable? (Note that this monetary economist would report the exact value, not an approximation.) a) 1.2% b) 5.0% c) 22.6% d) 26.0% e) 81.5%

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Answer:

The correct answer is the letter b, 5%.

Explanation:

The quantitative theory of money analyzes the relationship between money supply and price level, MV = PY, where M is the money supply, V is the speed of money, P is the price level, and Y is the real product. Thus, having Y = 6%, V = constant and M = 30%, we have:

MV = PY

30 (1) = P (6)

P = 30/6

P = 5%

That is, the inflation rate for the Brazilian economy based on the quantitative theory of the currency is 5%.

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