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Numeral Exercise 11

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Question: Numeral Exercise 11 Suppose that the Fed’s inflation target is 2%, potential output growth is 3….
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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 %
triangle Y 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 from 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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