Question

2. (20 points) According to classical macroeconomics policy, money supply shocks are "neutral" (a) Explain what this means. (b) Based on that theory, how would a 5% increase in a nation's money supply affect its real wage rate (), all else equal? I (c) According to the quantatity of money, how would a 5% increase in money supply affect the price of goods and services (P), all else equal? (d) To be consistent with both theories, what would have to happen to the nominal wage rate W)? Explain. to the nominal wage rate (W)? Explain 3. (30 points) Suppose that in the U.S., the income velocity of money (V) 0.025) and is constant and that the real GDP grows by 2.5% (%AY year 0.010)) the supply of money grows by 10 % ((%AM year (a) According to the Quantity Theory of Money, what would be the growth rate of nominal GDP P*Y? Hint: %A(X x Y) = %X + %Y MacBook Air (b) In that case, what would be the inflation rate (i.e. (%AP)). Hint: year If you did not solve part (a), %A Pay year assume 0.1 (c) If the central bank wants the inflation rate to be 0%, what money supply growth rate (i.e.%AM per year) should it set? MacBook Air 44 % L 7 3 4 6 elets E R W T Y U O P A D F G K

Answer 1

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