Suppose that the Fed\'s inflation target is 2%, potential output growth is 3.5%,

Question

Suppose that the Fed's inflation target is 2%, potential output growth is 3.5%, and velocity is a function of how much the interest rate differs from 5%: % triangle v=0.5x(i-5) Suppose that a model of the economy suggests that the real interest rate is determined by the equation: r =8.5-% triangle Y where Y is the level of output, so %triangleY is the growth rate of output. Suppose that people expect the Fed to hit its inflation target. A: Calculate the optimal money growth rate needed for the Fed to hit its inflation target in the long run. B: In the short run, if output growth is just 2% for two years and the equation determining the real interest rate changes to r = 4.5- %triangleY, what money growth rate should the Fed aim for to hit its inflation target in that period? C: If the Fed instead maintained the money growth rate froom part A, what is likely to happen to inflation? D: Which policy do you think is better in the short run?which is better in the long run?

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