Question

Suppose you have become the head of the country's central bank considering the adoption of a new nominal benchmark. Let's say the inflation rate was 4% at the time of inauguration, and that the task was to keep it within 2.5% for the next year. Currently, the real economic growth rate is 3 percent and the global interest rate is 1.5 percent. Let's say the monetary unit of this country is Lira. The price is assumed to fluctuate flexibly.

a) Why is a system of adopting nominal standards important in achieving the inflation target? What are the problems caused by adopting this system?

b) What is the rate of increase in money supply? Assuming that money supply can be adjusted, how should the rate of money supply be adjusted to achieve the inflation target?

Answer 1

(a) The system of adopting nominal standards is impirtimp in achieving the inflation target because a nominal value gives the total amount of money spent on the economy. The nominal standards gives the total amount of money in the economy. Therefore, in this method it is easier to achieve the inflation targets. In this method the nominal value of the goods and services is being shown. The nominal value has the infkainfl rate inclusive of it here. Hence, the nominal value iw generally greater than the real value(here, inflation country rate is not calculated). So, the nominal standard is important in achieving the inflation target.

This method of nominal standard does not show the real value of growth in the economy. This is a major problem of the nominal standards.

(b) Rate of increase in money supply us the rate of increase in the inflation rate. So, the rate of change if inflation rate will be, {(2.5 - 4)/2.5}*100 = -60%.

4% is the initial inflation rate. 2.5% is the target inflation rate. The money supply would decrease by 60% as the targeted inflation rate is lesser than the previous year.

The rate of money supply should be adjusted to achieve the inflation, as more the money supply in the economy, more the rates of inflation would be in the economy. With more money in the economy, the prices of the goods and services would increase, thus causing more inflation in the economy. By decreasing the rate of money supply in the economy the prices of the goods and services in the economy would be lower, thus the rate of inflation in the economy would also be lower.