Question

Suppose that the money demand function takes the form

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

a. If output grows at rate g and the nominal interest rate is constant, at what rate will the demand for real balances grow?

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?

e. If the central bank wants to achive a longrun target inflation rate of ?, at what rate should the money supply grow?

Answer 1