Question

Why is the nominal interest rate the opportunity cost of holding money? If the Fed makes the quantity of money grow at the same rate as the growth rate of real GDP and velocity does not change, in the long run, what happens to the price level and the inflation rate?

Answer 1

Why is the nominal interest rate the opportunity cost of holding money?

Answer:

Nominal interest rate is the opportunity cost of holding money because if the money is deposited, it can earn nominal interest. It is the next best alternative to holding money.

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If the Fed makes the quantity of money grow at the same rate as the growth rate of real GDP and velocity does not change, in the long run, what happens to the price level and the inflation rate?

Answer:

A price level is the average of current prices across the entire spectrum of goods and services produced in the economy.When people receive money, they eventually spend it by giving it to someone else in exchange for a product or service. In turn, the person who received the money will also eventually spend it Because real GDP is relatively change over the long run, an increase in money supply causes an increase in aggregate demand, which causes an increase in prices.

It is easy to see that if money growth is equal to increases in real GDP, then there will be no inflation. Hence, a fast-growing economy will allow the government to create more money to help pay for its services without causing inflation. Inflation results when money growth is faster than real GDP growth.