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%: %^V= 0.5 X (i-5). Suppose that a model of the economy suggests that the real interest rate is determined by the equation r= 8.35-%^Y where Y is the level of output, so %^Y is the growth rate of output. Suppose that people expect the Fed to hit its inflation target

Calculate the optimal money growth rate needed for the Fed to hit its inflation target in the long run

Explanation / Answer

So the goal is to obtain a 2% inflation target. "so %^Y is the growth rate of output" We need to find out %^Y to get our answer. r= 8.35-%^Y Since the interest rate is 5% we plug it into r. 0.05= 8.35-%^Y Subtract from both sides. -8.30 = -%^Y Multiply both sides by -1. %^Y = 8.30 And that's your answer. Hope this helps, best of luck.

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