Question

Consider an economy in which the money demand function takes the form:

(M/P) d = L (i, Y) = Y/(5i)

a. If output grows at rate g, at what rate will the demand for real balances grow (assuming constant nominal interest rates)?

b. What is the velocity of money in this economy?

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 of velocity? How will it affect the subsequent growth rate of velocity?

Answer 1

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