Question

The following problem illustrates Milton Friedman's money growth rule which is a center piece of the Monetarist thinking of macroeconomics. Suppose the economy is given by the following: Production Function: Yt = 10 Kt 0.4(Lt Et) 0.6 Consumption Function: Ct = 0.8 Yt Depreciation rate: 8% (i.e. δ = 0.08). Population growth: 2% (i.e. n= 0.02). Technological growth: 2% (i.e. g= 0.02). Money demand: ( ?? ?? ) ? = ? ?(?? ) = 2?? . In addition, suppose that L0 E0 = L0 = 100, M0 = 1000 and K0 is such that the economy is at the steady state. (Note, don't confuse the different notational uses for L.) a. Find the steady state level of kt, yt, ct, it . b. What is K0. c. What is Y0. d. What is P0. e. One important part of Milton Friedman's monetarist theory is the rule for money supply growth. This rule requires that the money supply grow at the same rate as GDP. It is argued that if this rule is followed, then long-term inflation can be avoided. To illustrate this result, we now apply Milton Friedman's rule to this example economy. Use the money growth rule to determine M1, the money supply at time 1. Hint1: remember on steady state GDP grows at rate n+g. Hint 2: if X grows at rate ɣ, Xt= X0(1+ ɣ) t. f. Show that if this rule is followed, P1 = P0 as Friedman predicts. g. Use Friedman's rule to determine M100. h. What will P100 be?

Answer 1