Question

Question 1 Not yet answered Marked out of 15.00 Suppose Saudi Arabia's real GDP growth rate is 5%. The government is interested in keeping inflation rate at 3%. 1. Explain how can the government achieve this target. What should the government do if inflation rate goes above or below 3% in the short run and why? Provide an examples support your answer. 2. Explain what should the government do to achieve the targeted level of inflation if the growth rate of real GDP was unexpectedly reduced to 1% due to Cavid-19. P Flag question Paragraph - BIELE Path:p

Answer 1

Real GDP growth rate = 5%

Target inflation rate = 3%

1.

Growth version of quantity theory of money says that:

% change in Money + % change in velocity = % change in Price + % change in Real GDP

We assume that the velocity is constant. So, % change in velocity = 0

In order to keep the inflation at 3% with 5% Real GDP growth rate, the government should increase the money supply by 8%. Government should adopt Expansionary Fiscal Policy to do the same. Higher government spending will increase the domestic aggregate demand for goods and services. Higher demand raises the general price level.

Government should adopt Contractionary Fiscal Poloicy if the inflation rate goes below 3% and Expansionary Fiscal Fiscal if it goes above 3%

2.

If the growth rate of real GDP is unexpectedly reduced to 15, then the economy will be in a recessionary gap. So, the Government should adopt Contractionary Fiscal Policy and decrease the money supply by 4%

Growth in Money Supply - Inflation = Growth in Real GDP