Question

d) Suppose that the central bank follows a Friedman Rule. This means that they set money growth at a constant rate. Suppose they choose a nominal money growth rate of 2%. Over several decades the average growth rate of nominal GDP is 3% per year and the average change in the nominal interest rate is 0%. The nominal interest fluctuates in the short run. • What is the average inflation rate in the long run? • Is the quantity theory a good approximation of price level determination over the long run? What about the short run? • Evaluate the statement that by Milton Friedman that "Inflation is al- ways and everywhere a monetary phenomenon." Discuss the Classical Dichotomy in your answer. Make use of the following equation: %AM - WAP =%AY - 2%Ai

Please provide clear and specific answer. Please note that nominal GDP = P * Y. Thank you in advance.

Answer 1

Answer forom the giren date we have done & Let change in ereal GDP be fixed in the long run. Given Charge in a interest rate =0 - Then I change in money growth=% Change in Price level = - therefore inflation in norminal rate= 2% inflation . - But in the long run increase in nominal GoP= 3% -) thertore avg inflation rate in long run= 3% (Provided change in red GDP=0 and change in inflation & change in real GDP = change in nominal GDP) 6 Many Economist belive that, In the long run it velocity of circulation and volume of goods and services are kept to be constant, Price level is directly - Proportional to inflation. - But this is not the Case always. Some believe that Production spending etc are responsible for Economics of the Country and money supply doesn't have a long term Effect. » In the short term velocity of circulation and volume of goods and services are highly variable - Also Pruce levels always lags in action responding to an - immediate monetary Policy.

=> Therefore Quantity theory is not followed in Shoot on @ +® Milton Friedman Says that inflation is directly dependent, on the supply of money 1. Let us See auantity Ear which States that Money Supply x velocity of Money = Price level x real GDP] - from classical Dichotomy model, we can say that real variables and nominal variables. > If we consider them to be constant, then money Supply is directly proportional to the Price level Therefore we can say that as Supply of money increases so I does Price level which in turn will drive up intilation. - this forms the basis of all monetary Policies according to .. milton Friedman. - In the short term however Price levels Sometimes lags behind money flow therefore this is not applicable in the Short run. e highly volatile in the Short run, = Also velocity of money is highly volatile low = O = 1 x * Please rate * *7