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Unformatted text preview: foreign country whose money the small country decides to use. If the foreign country is more stable than the home country, then it is safer to choose to use their money rather than print own money, vice visa . 7. a. (M/P)d=L(I,Y)=Y/(5i)=g b. 5i MV=PY so, M/P=Y/V=Y/(5i) V=5i c. g M(g)+V=P +Y 10. Increase in M leads to an increase inflation. Then nominal interest rate rises correspondingly. As a consequence, people now feel more risky of holding money. As a result, total money balance tends to fall. Since real money balance is part of wealth, real wealth also falls. Consumption will decline as well ,and, therefore, increases saving. This leads to a lower real interest rate. According to Fisher effect: i = r + In this case, since the real interest rate r falls, the change in inflation increases the nominal interest rate i by less than the change itself....
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