Assume velocity is constant, real income is constant at Y ¯= 200 and that the demand for real money balances is given by:
L(i, Y ) =Y/√i (9)
(a) If expected inflation is zero, the nominal interest rateis i = 0.25 and the price level is P = 1,
what must the Bank of Canada have set the money supply at?
(b) Taking that level of the money supply as fixed, suppose nowthat people expect the Bank of Canada to raise the money supply by11% over the next year, what will be the new price level today?Explain each stage of your answer carefully. Hint: expectedinflation will change.