Question

Suppose that the real money demand function is 𝐿(𝑌, 𝑟 + 𝜋 𝑒 = 0.3𝑌 𝑟 + 𝜋 𝑒 Where Y is real output, r is the real interest rate, and πe is the expected rate of inflation. Real output is constant over time at Y = 1500. The real interest rate is fixed in the goods market at r = 0.5 per year. (a) Suppose that the nominal money supply is growing at the rate of 10% per year and that this growth rate is expected to persist for ever. Currently, the nominal money supply is M = 400. What are the values of the real money supply and the current price level? (Hint: What is the value of the expected inflation rate that enters the money demand function?). (10) (b) Suppose that the nominal money supply is M = 400. The Bank of Namibia announces that from now on the nominal money supply will grow at the rate of 5% per year. If everyone believes this announcement, and if all markets are in equilibrium, what are the values of real money supply and the current price level? (10) .

Answer 1

(a) inflation rate=growth rate of money supply-growth rate of output

$0.1-0.005=0.095×100=9.5$ %

Growth rate of supply+growth rate of money=inflation rate+growth rate of output

$0.1+v=0.095+0.005$

$0.1+v=0.1$

$V=0$

Current price level=(nominal money supply×velocity of money )/real output

$400÷0=0$

Real money supply=nominal money supply/price level

$400÷0=400$

(b)inflation rate=growth rate of money supply-growth rate of output

$0.05-0.005=0.045×100=4.5$ %

Growth rate of supply+growth rate of money=inflation rate+growth rate of output

$0.05-v=0.045+0.005$

$V=0$

Current price level=(nominal money supply×velocity of money )/real output

$4000÷0=0$

Real money supply=nominal money supply/price level

$400÷0=400$