1. (Equation of Exchange)Using the equation of exchange, show why fiscal policy alone cannot increase nominal GDP if the velocity of money is constant.

The equation of exchange isM V = P Y. ..

The equation of exchange is M V = P Y. Fiscal policy does not change the money supply rather; it influences aggregate demand. Therefore, if V is stable, fiscal policy cannot change P Y. Without a change in M or V, P Y cannot change.

1. (Money Supply Versus Interest Rate Targets)Assume that the economy's real GDP is growing.

1. What will happen to money demand over time?
2. If the Fed leaves the money supply unchanged, what will happen to the interest rate over time?
3. If the Fed changes the money supply to match the change in money demand, what will happen to the interest rate over time?

d. What would be the effect of the policy described in part (c) on the economy's stability over the business cycle?