Problem 7.4: Ination and Government Expenditures 2. (30 points) Consider an economy in which quantity theory holds: 'V 2 Pg)\"; velocity and output are constant; and the government's budget constraint is: 13th = T: + Jl'irt+1 irt where Pth is nominal government spending, T; is nominal tax revenue, and M; is the money supply. Suppose that government spending is equal to 20% of GDP and taxes are equal to 10% of lGDP. Assume that velocity is constant and equal to 2. (a) Calculate the rate of money growth required for the government to finance its spending and the effect of this increase in the money supply on inflation. How do your answers change if velocity were 5 instead of 2? (b) Suppose instead that the central bank of this economy is a strict inflation targeter and refuses to print money to finance government spending. The government is thus forced to finance all its spending by setting taxes equal to 20% of GDP. Which of these two policies (printing money vs. raising taxes) does the public prefer? Assume that there are no costs of printing money and no costs of inflation. (c) Printing money to finance government spending is often referred to as an inflation tar. As- suming no costs of printing money or costs of inflation, why is inflation a tax? Who is the government implicitly taxing? Explain why countries that have trouble collecting tax revenues to finance government spending typically experience greater rates of inflation