Question

1.    Assume the monetary policy curve to be r=1.5+0.75 π
   1. Calculate the real interest rate when inflation rate is 2%, 3%, and 4%
   2. Draw the MP curve

Answer 1

Solution:-

(A) To find the real interest rate at various inflation levels (π), solve for r in the monetary policy (MP) curve r = 1.5 + 0.75π with the given values of π as follows

(I). When π = 2 : r = 1.5 + 0.75 (2)
= 1.5 + 1.5
= 3%

(II). When π = 3 : r = 1.5 + 0.75 (3)
= 1.5 + 2.25
= 3.75%

(III) When π = 4 : r = 1.5 + 0.75 (4)
= 1.5 + 3
= 4.5%

(B). The MP curve below Illustrates the respective values of r and π as calculated in part (A).