VE Exercise 4 ((7.5 points.) The Fiscal Deficit and the Inflation Tax). Suppose the demand for real money balances is of the form M . where Me is the demand for nominal money balances in year t, P is the price level in year t, ie is the nominal interest rate in year t, and Y is real output assumed to be constant and equal to 1. Suppose that the real interest rate, denoted r, is zero, and that the money growth rate, denoted y, is constant and equal to 50 percent per year, so that Me = 1.5 x M-1, for t = 0,1,2,..., where M, denotes the nominal money supply in year t. Assume further that the real fiscal deficit, denoted DEF, is constant, and that the government has exhausted its ability to finance it issuing debt. Finally, suppose people have rational expectations. Calculate the real fiscal deficit, DES, that the government is financing with the inflation tax. VE Exercise 4 ((7.5 points.) The Fiscal Deficit and the Inflation Tax). Suppose the demand for real money balances is of the form M . where Me is the demand for nominal money balances in year t, P is the price level in year t, ie is the nominal interest rate in year t, and Y is real output assumed to be constant and equal to 1. Suppose that the real interest rate, denoted r, is zero, and that the money growth rate, denoted y, is constant and equal to 50 percent per year, so that Me = 1.5 x M-1, for t = 0,1,2,..., where M, denotes the nominal money supply in year t. Assume further that the real fiscal deficit, denoted DEF, is constant, and that the government has exhausted its ability to finance it issuing debt. Finally, suppose people have rational expectations. Calculate the real fiscal deficit, DES, that the government is financing with the inflation tax