Question

Question 3: The Quantity Theory and the Fisher Effect [16 Points) Suppose that in El Salvador the velocity of money is constant, real GDP falls by 1.4% per year, the stock on money grows by 8.9% per year, and the nominal interest rate is 4.5%. (a) According to the quantity theory, what must the inflation rate be in El Salvador? [4 Points] (b) Calculate the real interest rate in El Salvador [2 Points] (e) Suppose that the central bank decides to decrease the money growth rate to 5% per year in El Salvador (%AM = 5%). Assume that the classical dichotomy holds. Calculate the nominal interest rate after the decrease in the growth rate of the money supply. [6 Points] (d) Briefly discuss two social costs associated with an expected increase of inflation [4 Points]

Answer 1

in Inswer page:01 (a) Inflation rate According to the quantity theory >> percentage change in + percentage change - 4. change money supply velocity price + percentage change in out put. 8.9.1. tol. = x + - 1.4.1. 8.9.4. +1.4.) > 10.3.1.) → inflation rate (6) real interest rate Real interest rate nominal Plerest 4.57, -10.311. 5.8:47 (c) nominal interest rate often the decreque in the af money supply often decrease in money supply 5.1. toila = *-1.4.1 * 6.4.0.) X х inflation rate growth rate

2 nominal interest rate page:02 Real enterest rate + inflation rate -5.8.1. + 6.4.1. = 10.6.1. (d) Two Social costs associated with an $ inflation Reduction rate (ii) Reduction in real returns on savings. esputed increase in real wege 6)