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Answers to Practice Exercises for Chapter 5 1. Answers to Analytical Exercises Exercise 1 People who hold their wealth in the readily-spendable form of non-interest bearing money pay the inflation tax. The government collects it by printing money and spending it. Exercise 3 Real GDP is growing at 4% per year. (This follows from the fact that Y=K α × ( E × L ) 1– ; and the rate of growth of K is the same as the rate of growth of × .) But total demand for real money balance is growing at the difference between real GDP and velocity growth—3% per year. Thus the nominal money stock needs to grow at 3% per year in order to achieve a stable price level. 2. Answers to Policy Exercises Exercise 5 A falling rate of inflation means that nominal interest rates are likely to be lower, and so the cost of holding wealth in readily-spendable form—real money balances—is likely to be lower. Since its cost is lower, people are
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Unformatted text preview: likely to want to hold a larger share of their wealth in the form of real money balances. So the velocity of money is likely to fall. 3. Same answer as the case we did in class: see pp. 224-226 in the book. Note, that real variables such as r and Y are not affected by innovations in the money market because of the neutrality of money in the flexible price – full employment model. 4. The ex-ante real interest rate i.e. the real return in terms of goods that the bank expects to receive and the firm expects to pay is r e = i – π e = 10 –5 = 5%. However π < π e (3% < 5%) and thus the ex-post real interest rate i.e. the real return that the bank actually receives (and the firm pays) is higher than the ex-ante one: r = i-π = 10 – 3 = 7 > 5% = r e . In this case the creditor (bank) benefits....
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This note was uploaded on 04/17/2010 for the course LAPS ECON2350 a taught by Professor Barrysmithandtasso during the Spring '10 term at York University.

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