Numeral Exercise 11Suppos

Numeral Exercise 11Suppos

Numeral Exercise 11Suppose 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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