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5. Inflation (20 points). An economy has the following money demand function (M/P) d = 4YI(i) where M represents the money supply, P represents the
5. Inflation (20 points). An economy has the following money demand function (M/P) d = 4YI(i) where M represents the money supply, P represents the price level, Y represents output, and i represents the nominal interest rate. For this problem, express all interest rates in terms of percentages (not in decimal form). a.) Assume the nominal interest rate i is 8 percent. If output Y is 20 and the money supply M is 100, what is the price level P? (Note: use the interest rate in terms of percentage, not in decimal form.) b.) Suppose the central bank announces a softer stance on inflation which raises inflation expectations by 4 percentage points. According to the Fisher effect, what is the new nominal interest rate? c.) A general form of the money demand function is (MIP) d = Y/V. This equation implies demand for real money balances depend on the velocity of money, V. What is meant by the term "real money balances?" What about "velocity of money?" Write the meaning of these terms below. d.) Using the equation for money demand given at the beginning of the problem and the general form given in part c.), calculate the velocity of money when the nominal interest rate is 8 percent and after it changes following the central bank announcement
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