Question

1) Using the quantity theory of money and fisher equation , explain how money growth affect the nominal interest rate?

2) Derive the demand for money , using the money demand and money supply curves , show how rate of interest change with the decrease in money supply

3) explain how the overall supply of money depends on the supply of high powered money

4) explain the cost of unexpected inflation

Answer 1

Answer:

1]The Fisher Effect states that the real interest rate equals the nominal interest rate minus the expected inflation rate. Therefore, real interest rates fall as inflation increases, unless nominal rates increase at the same rate as inflation.

2]The equation for the demand for money is: Md = P * L(R,Y). This is the equivalent of stating that the nominal amount of money demanded (Md) equals the price level (P) times the liquidity preference function L(R,Y)–the amount of money held in easily convertible sources (cash, bank demand deposits).

3]The supply of money at any moment is the total amount of money in the economy. There are three alternative views regarding the definition or measures of money supply. The most common view is associated with the traditional and Keynesian thinking which stresses the medium of exchange function of money.

4]Unexpected inflation is the inflation experienced that is above or below that which we expected. Unexpected inflation affects the economic cycle. Unanticipated inflation reduces the validity of the information on market prices for economic agents.  It leads to high-risk premiums and economic uncertainty.

Explanation: