Consider an economy in which the demand for money is of the form Y /(1+it) for t = 0, 1, 2, . . ., where Y denotes a constant level of output and it denotes the nominal interest rate in period t. The real interest rate, denoted r, is constant and equal to 4%. In period 0, the nominal interest rate is 15%, and the money supply is 100. People have rational expectations. In period 1, the central bank surprises people and sets the money supply to 104 and announces that starting in period 2 the money supply will grow at 2 percent forever, that is, Mt/Mt1 = 1.02 for t = 2, 3, . . .. Find the inflation rate in period 1. Compare it to E01.
Now consider the same economy as in the previous question, except that people do not have rational expectations. Assume instead that E12 = E01, where Ett+1 1 denotes the expected value in period t of inflation in period t + 1. Find the inflation rate in period 1.
Consider an economy in which the demand for money is of the form Y /(1+it) for t = 0, 1, 2, . . ., where Y denotes a constant level of output and it denotes the nominal interest rate in period t. The real interest rate, denoted r, is constant and equal to 4%. In period 0, the nominal interest rate is 15%, and the money supply is 100. People have rational expectations. In period 1, the central bank surprises people and sets the money supply to 104 and announces that starting in period 2 the money supply will grow at 2 percent forever, that is, Mt/Mt1 = 1.02 for t = 2, 3, . . .. Find the inflation rate in period 1. Compare it to E01.
Now consider the same economy as in the previous question, except that people do not have rational expectations. Assume instead that E12 = E01, where Ett+1 1 denotes the expected value in period t of inflation in period t + 1. Find the inflation rate in period 1.
