Question

· Inflation (Mankiw Ch. 5 #3). An economy has the following money demand function: (M/Pd = .2Y/i1/2) a.) Derive an expression for the velocity of money. What does this velocity depend on? Explain why this dependency may occur. b.) Calculate the velocity if the nominal interest rate i is 4 percent. c.) Assume the nominal interest rate i is still 4 percent. If output Y is 1,000 units and the money supply M is $1,200, what is the price level P? d.) Suppose the announcement of a new head of the central bank, with a reputation of being soft on inflation, increases expected inflation by 5 percentage points. According to the Fisher effect, what is the new nominal interest rate? e.) Calculate the new velocity of money. f.) If in the aftermath of the announcement, both the economy's output and the current money supply are unchanged, what happens to the price level? Explain why this occurs (hint: think about the impact on real money demand). g.) If the new central banker wants to keep the price level the same after the announcement, at what level should she set the money supply?

Answer 1

JT CaTn) NV PY P J P o-29 N 0.21 5 T the cest f huldigcma Put ie 41ucsog intesest xde is 4 4-1) Y V 5 o4 V (5) (0.u) MV APNV p-(120) (1) vis at i 4 1ouo .2

पा ১ n. Ai ArtATE New itAi - 4 51 i new decyuney Vs 5 J0:09 Nes V1.5 n the afemeh beth and M Yemain uachanged e Nes Pice P12)(5) P Prides (leade geaple speadng inca V mer Tiles, So as lefare ie91. V1.5 PRemah t 1-2 .2 (ous) To.ug M 0.2 12