Exercise 3: Price Level and Inflation Consider an economy in a steady-state with growing money supply, growing output and a constant real interest rate. Money supply grows at a constant rate # = 0.05, such that Mit = (1 + #) Mi. Output grows at a constant rate g = 0.02, such that yi+1 = (1 + g)yt. 2 Econ 4721-Money and Banking HW 2 Recall the equilibrium condition for money: Mi = mi(y, i)p. where M' is the money supply, m" (y, i) is real money demand and p, is the price level of the economy (think of this as the price index). Recall from our discussion in class, that we can think of the nominal interest rate as: it = n + 7 where it is the inflation rate. (For the following questions, you are advised to follow closely your class notes) a) (10 points) Assume that real money demand takes the following form: my (yt, it) = you Find the implied inflation rate as a function of the growth rate of money, the growth rate of output and the elasticity of money demand with respect to output (as we did in class, let's call this term n).b) (10 points) Repeat part a) but assume instead that the money demand is of the following form: my (yt, it) = yi(1 + it)- c) (10 points) Repeat part a) but assume instead that the money demand is of the following form: my (ye, it) = 2it where a = 0.5 (notice that this is just the Baumol-Tobin demand function that we derived in class)