Monetarism cautions that the money supply should grow at a rate equal to the long-run growth rate of real GDP.

• A. A rate higher than real GDP growth helps reduce unemployment.
• B. A rate equal to real GDP growth.
• C. A rate lower than real GDP growth.
• D. There is no fixed rule.

Answer: (B)

Monetarists argue that, in the long run, money is neutral: changes in the money supply affect the price level, not real output. If velocity is roughly stable and real GDP grows at a certain rate, expanding the money supply at that same rate keeps nominal GDP growing in line with real GDP, so prices stay stable. That’s why the best choice is a growth rate of the money supply equal to the long-run growth rate of real GDP. If money grows faster, inflation rises; if it grows slower, inflation falls or deflation can occur. In the long run, monetary policy doesn’t reliably reduce unemployment, so there isn’t a rule that says higher money growth lowers unemployment permanently.