Question 3 (7 marks) Assuming that velocity and output were fixed, the basic Quantity Theory implies inflation equals the growth rate of the money
Question Question 3 (7 marks) Assuming that velocity and output were fixed, the basic Quantity
Theory implies inflation equals the growth rate of the money supply, o = KAM.
a) (1 mark) Derive this relationship from the equation of exchange.
The rate of return on money is related to the inflation rate: %AQ, = - [x/(100 + x)]100 .
b) (2 marks) Under the basic Quantity Theory, what is the functional relationship between the
rate of return on money and the growth rate of the money supply? If the rate of growth of
the money supply is -12%, what is the rate or return on money?
During the Great Depression, the price level at end of 1929 is Piss, = 1, and the value of
money increases by 50% over the three years from the end of 1929 to end of 1932.
() (3 marks) What is the implied price level at the end of 1932? What is the average inflation
rate from the end of 1929 to 1932? What is the average rate of return on money from the
end of 1929 to 1932?
In reality rates neither output nor velocity were constant. From the end of 1931 to the end of
1932. output falls by 17%, velocity falls by 12%% and the price level fell 10%. (Hint: equation
of exchange)
d) (1 mark) What is the implied growth rate of the money supply in 1932?

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