Suppose the velocity of money is not fixed, but stable at about 4% 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 version with velocity growing at about 4% per year, what would the growth rate of the other variables 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 4% instead of 0%. 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 4% growth rate of the velocity of money exceeds the growth rate of real GDP. Therefore, the growth rate of the money supply must be 4 percentage points less than the growth rate of real GDP or inflation will occur.
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