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Suppose a country has a money demand function (M/P)d = kY, where k is a constant parameter. The money supply grows by 12 percent per
Suppose a country has a money demand function (M/P)d = kY, where k is a constant parameter. The money supply grows by 12 percent per year, and real income grows by 4 percent per year.
i. What is the average inflation rate?
ii. How would inflation be different if real income growth was higher? Explain.
iii. Suppose, instead of a constant money demand function, the velocity of money in this economy was growing steadily due to financial innovation. How would this affect the inflation rate? Explain.
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