6. Suppose that the real money demand function for Ecuador is:

where Y is real output, r is the real interest rate, and pe is the expected rate of inflation. Real output is constant over time at Y = $150 billion. The real interest rate is fixed in the goods market at r = 0.05 per year.

a. Suppose that the nominal money supply is growing at the rate of 10% per year and that this growth rate is expected to last in the years to come.
Currently, the nominal money supply is M = 200.
What are the values of the real money supply and the current price level? (Hint: What is the value of the expected inflation rate that enters the money demand function?)

b. Suppose that the nominal money supply is still M = 200. The central bank announces that from now on the nominal money supply will grow at the rate of 5% per year. If everyone believes this announcement, and if all markets are in equilibrium, what are the values of the real money supply and the current price level? Explain the effects of a slowdown in the rate of money growth on the real money supply and the current price level.

Transcribed Image Text:

L(Y, r+) == 0.1Y r + pe