Answer Happy

(a) [5 marks] In the context of the Quantitative Theory of Money comment on the following sentence: "In order for inflation to be constant, the growth rate of the money supply should be equal to the growth rate of real output". (b) [3 marks] Write down the "Fisher Equation" and explain the Fisher effect. (c) [5 marks] Suppose that the velocity of money is not constant, and it is related to the nominal interest rate, such that the velocity is a function of the nominal interest rate: V(i). Explain how the velocity of money would change when the nominal interest changes. (d) [8 marks] Consider the equilibrium in the money market is given by M/P=L(Y,i), where M denotes the money supply, P the fixed aggregate price level, i denotes the nominal interest rate and Y aggregate real income. Suppose that the money market starts at the equilibrium. Now assume that money supply is increased (everything else constant). Using a diagram to illustrate your answer, explain how the interest rate adjusts to maintain the money market equilibrium in the context of the "theory of liquidity preference". (e) [4 marks] Suppose we are in the long run and the aggregate price level is flexible. Using the Fisher question in the money market equilibrium condition M/P=L(Y,i), as in (c), explain how an increase in expected inflation (everything else constant) will affect the aggregate price level.