2. Answer all parts (a)-(e) of this question. (a) [5 marks] In the context of the Quantitative Theory of Money comment o

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2. Answer all parts (a)-(e) of this question. (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.