# IV.D. - Barro Ch.11 PP 3-6 3. Inflation and Interest Rates...

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IV.D. Inflation and Interest Rates This section links money growth to inflation and inflation to interest rates. 1. Money Growth and Inflation We know according to Money Neutrality that an increase in the money supply should price a proportionate increase in the price level. This implies if money grows at a constant rate, then prices should also grow at a constant rate. The growth rate in the price level is called the inflation rate. Money Neutrality predicts that there will be a strict one-to-one relationship between money growth rates and inflation rates. Barro Ch.11 PP 1-2 2. Actual and Expected Inflation Rates

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Unformatted text preview: Barro Ch.11 PP 3-6 3. Inflation and Interest Rates Nominal interest rate (i) gives the growth in the dollars created by an asset over time. dollar value in year 2 = dollar value in year 1(1 + i) Real interest rate (r) gives the growth in the purchasing power of an Real value of asset in year 2 = dollar value in year 2/ = (dollar value in year 1 (1 + i))/ = real value of asset in year 1 (1 + i))/ = real value of asset in year 1 (1 + i))/ (/) = real value of asset in year 1 (1 + i))/ () We define 1 + r = (1 + r )( ) = 1 + i + r + r = 1 + i...
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## This note was uploaded on 02/19/2011 for the course ECON 251 taught by Professor Blanchard during the Spring '08 term at Purdue University-West Lafayette.

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IV.D. - Barro Ch.11 PP 3-6 3. Inflation and Interest Rates...

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