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Decrease in the rate of nominal money growth

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The effects of a permanent decrease in the rate of nominal money growth

Suppose that the economy can be described by the following three equations:

ut - ut-1 = -0.41gyt - 3%2 Okun's law

pt - pt-1 = -1ut - 5%2 Phillips curve

gyt = gmt - pt Aggregate demand

a. Reduce the three equations to two by substituting gyt from the aggregate demand equation into Okun's law. (Okun's law was presented in Chapter 2.)

Assume initially that ut = ut-1 = 5%, gmt = 13%, and pt = 10%.

b. Explain why these values are consistent with the statement "Inflation is always and everywhere a monetary phenomenon." Now suppose that money growth is permanently reduced from 13% to 3%, starting in year t.

c. Compute (using a calculator or a spreadsheet program) unemployment and inflation in years t, t + 1, c, t + 10.

d. Does inflation decline smoothly from 10% to 3%? Why or why not?

e. Compute the values of the unemployment rate and the inflation rate in the medium run.

f. Is the statement that "Inflation is always and everywhere a monetary phenomenon" a statement that refers to the medium run or the short run?

Reference no: EM132431360

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