1.1. This chapter is concerned mostly with how monetary policy might be able to return an economy quickly to the Solow growth rate after a shock. But as we aw in Chapter 12's discussion of the quantity theory of money, a market economy has a correction mechanism to return itself slowly to the Solow 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 ofKydland. Before the ----+

shock to Kydland's economy, M = 10%, v = 3%, real growth = 4%. What is inflation? ----+

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?