Question

The income elasticity of money demand is 1.00 and the interest elasticity of money demand is -0.10. Real income is expected to grow by 3.3% over the next year, and the real interest rate is expected to remain constant over the next year. The rate of inflation has been zero for several years. a. If the central bank wants zero inflation over the next year, what growth rate of the nominal money supply should it choose? % delta M = 3.3 (enter your response rounded to two decimal places). b. By how much will velocity change over the next year if the central bank follows the policy that achieves zero inflation? % delta V = (enter your response rounded to two decimal places).

Answer 1

Answer:

• 3.30%
• 0.00%

Explanation:

income elasticity of money demand = 1

interest elasticity of money demand = - 0.10

Real income growth rate = 3.3 %

A) to achieve zero inflation rate next year

applying the quantity theory of exchange

% change in M + % change in V = %change in price + %change in real income

= 3.3 + 0 = 0 + 3.3%

hence the growth rate nominal money supply the central bank should choose is 3.3%

B) %change in V  can be calculated

applying this formula

% change of V = %change in price + %change in real income - %changeinM

= % change of V = 0 + 3.3 - 3.3

therefore %change of V if the central bank follows the zero inflation policy = 0%