Why is the nominal interest rate the opportunity cost of holding money? If the Fed makes...

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?

Expert Solution

Nominal interest rate is opportunity cost of holding money because nominal interest rate is addition of real interest rate on an alternative asset and the expected inflation rate which a rate at which money lose buying capacity.

Price level as well as inflation rate remains constant because we know that,

Growth rate of money supply+ growth rate of velocity of money= inflation rate+ growth rate of output ( real GDP)

If growth rate of money supply and Real GDP increases at same rate then to maintain equation inflation rate must be depend on growth rate of velocity of money as it is constant so inflation rate must be constant.

Similarly,

Quantity theory of money

Money supply*velocity of money = price level* real GDP

Velocity of money= price level if money supply and real GDP grows at same level so price level will remain constant

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Rahul Sunny answered 1 year ago

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Why is the nominal interest rate the opportunity cost of holding money? If the Fed makes...

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