Assume that wages and prices are sticky and that we start at a long-run equilibrium. Assume that at this initial point, the growth rate of the money supply is 4%, the growth rate of the velocity of money is 3% and that the real economic growth rate is 5%. Now assume that there is a negative real shock. After the negative real shock, the inflation rate in the economy is 7%. Now assume that the federal government decides to increase government spending in order to combat the situation resulting from the rise in oil prices. After the increase in government spending, the growth rate of the velocity of money is 8%.
1. After the federal government increases government spending, what is the growth rate of the money supply?
2. After the federal government increases government spending, what is the inflation rate in your graph?