2.1 Inating away existing debt We now show how the government can 'cheat' lenders and inate away existing debt by issuing new money (increasing money supply) and thus reducing the real value of existing nominal debt. We start with the government budget constraint for period 2, express in real terms. In the previous section, you were asked to derive this constraint in the form - (2) The left-hand side are the real expenditures of the government in period 2 it must pay for expenditures G2 and the real value of the debt plus interest. The righthand side is the tax revenue and real value of newly issued money (see previous derivations). Question 2.3 Consider the quantity theory of money under classical dichotomy. Imagine that the velocity and output are constant. What is the relationship between the the ination rate 172 and the growth rate of the money supply, saw