Suppose that the money demand function takes the form (??)?=?(?,?)=?/5? where ?i is the nominal interest...

Suppose that the money demand function takes the form

(??)?=?(?,?)=?/5?

where ?i is the nominal interest rate, and ?Y is the real output (income).

a. If output grows at a rate of g, and the nominal interest rate is constant, the demand for real balances will grow at a rate of

b. What is the velocity of money in this economy? (Note that the equation will be case sensitive. Please use the case indicated by the text.)

V =

c. If inflation and nominal interest rates are constant, at what rate, if any, will velocity grow?

d. How will a permanent (once-and-for-all) increase in the level of interest rates affect the level and growth rate of velocity?

A one-time increase in the nominal interest rate will cause a one-time increase in the growth rate of velocity, but it will not affect the level of velocity.

A one-time increase in the nominal interest rate will cause a one-time increase in velocity, and the growth rate of velocity will now be positive.

A one-time increase in the nominal interest rate will cause a one-time increase in velocity, but it will not affect the growth rate of velocity.

A one-time increase in the nominal interest rate will cause a one-time increase in velocity, and the growth rate of velocity will now be negative.

e. Suppose the central bank wants to achieve a long-run target inflation rate of ?π. At what rate should the money supply grow?

Expert Solution

Rahul Sunny answered 2 years ago

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