Calulate the optimal money growth rate needed

Reference no: EM13293196

Suppose that the Fed's inflation target is 2%, potential output growth is 3.5%, and velocity is a function of how much the interest rate differs from 5%: %^V= 0.5 X (i-5). Suppose that a model of the economy suggests that the real interest rate is determined by the equation r= 8.35-%^Y where Y is the level of output, so %^Y is the growth rate of output. Suppose that people expect the Fed to hit its inflation target

a. Calulate the optimal money growth rate needed for the Fed to hit its inflation target in the long run.

b. In the short run, if the output is just 2 percent for two years and the equation determining the real interest rate changes to r = 4.5 - %^Y, what money growth rate should the Fed aim for its hit its inflation target in that period?

Reference no: EM13293196

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