1 . a) In the long run, prices are áexible. According to the quantity theory of

Question

1 . a) In the long run, prices are áexible. According to the quantity theory of money, what are the e§ects of a 12% increase in the money supply in the long run? b) You are told that Korea raises its money growth rate from 10% to 15%. Koreaís rate of real GDP growth is 8%. What is the rate of ináation before and after the change? c) If the nominal interest rate is 5% and ináation is 3%, what is the real interest rate? If an increased rate of money growth raises the rate of ináation to 6% in the long run, what happens to the nominal interest rate according to the Fisher e§ect?

Explanation / Answer

1 . a) In the long run, prices are áexible. According to the quantity theory of money, what are the e§ects of a 12% increase in the money supply in the long run?

Quantity theory of money assumes that increase in money supply only leads to the increase in inflation or fall in the value of money. 12 % increase in the money supply shall cause 12 % increase in prices.

b) You are told that Korea raises its money growth rate from 10% to 15%. Koreaís rate of real GDP growth is 8%. What is the rate of ináation before and after the change

when the Korea rate of increae in money supply was 10 %, the inflation was 2 % since the growth rate was 8 % ( 10 - 8). Further, jump to the 15 % increase in the money supply will cause 7 % inflation.

c) If the nominal interest rate is 5% and ináation is 3%, what is the real interest rate? If an increased rate of money growth raises the rate of ináation to 6% in the long run, what happens to the nominal interest rate according to the Fisher e§ect?

Fisher effect , adjustment of nominal rate of interest rate to changes in ifnlation rate is called Fisher effect. Real rate of interest = 5% -3 %

=2 %

Nominal rate of interest = real rate of interest + rate of inflation

=2 % +6%

=8%

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