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 saw in Chapter 29’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. lop5

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Recall that: M += Inflation + Real growth a. Consider the nation of Kydland. Before the shock to Kydland's economy, M = 10%, =3%, real growth = 4%. What is inflation?