Question

1. The government of a country increases the growth rate of the money supply from 5 percent per year to 50 percent per year. What happens to prices? What happens to nominal interest rates? Why might the government be doing this?

2.List and describe six costs of inflation. /6

3.Explain how an increase in the price level affects the real value of money. /2

4.According to the quantity theory of money, what is the effect of an increase in the quantity of money? /1

5.Explain the difference between nominal and real variables and give two examples of each. /4

6.    Using the quantity theory of money, suppose that this year’s money supply is $50 billion,                                                                                                            nominal GDP is $1 trillion, and real GDP is $500 billion. /8

a. What is the price level? What is the velocity of money?

b. Suppose that velocity is constant, and the economy’s output of goods and services rises by 5 percent each year. What will happen to nominal GDP and the price level next year if the Bank of Canada keeps the money supply constant?

c. What money supply should the Bank of Canada set next year if it wants to keep the price level stable?

d. What money supply should the Bank of Canada set next year if it wants inflation of 10 percent?

Answer 1

Answer 1 - If the government raises the supply of money from 5 to 50 % there will be excess of money supply in economy. This will lead to the rise in demand in the economy. As a result the condition of inflation will be created in the economy. The price levels will rise. The nominal interest rates decrease as a result of greater money supply. The real interest rates might turn negative due to excessive inflation. The government might be planning to boost the demand in economy suffering from high degree of recession and formulated this expansionary policy.