Question: This chapter is concerned mostly with how monetary policy might be able to return an economy quickly to the potential growth rate after a shock. Discussion of the quantity theory of money, a market economy has a correction mechanism to return itself slowly to the potential growth rate after a shock: flexible prices. Let's review the quantity theory, and remember that in the quantity theory, inflation does all of the adjusting. Recall that: M→+ v→ = Inflation + Real growth
a. Consider the nation of Kyd land. Before the shock to Kyd land's economy, M→ = 10%, v→ = 3%, real growth = 4%. What is inflation?
b. In Kydland, v→ falls to 0%, but M→ stays the same. In the long run, what will inflation equal? What will real growth equal?
c. Consider the nation of Prescottia. Before the shock to Prescottia's economy, M→ = 2%, v→ = 4%, real growth = 2%. What is inflation?
d. In Prescottia, v→ rises to 8%. In the long run, what will inflation equal? What will real growth equal?
e. Consider the nation of Friedmania. Before the shock to Friedmania's economy, M→ = 3%, v→ = 0%, real growth = 3%. What is inflation?
f. In Friedmania, M→ falls to 1%. In the long run, what will inflation equal? What will real growth equal?