Suppose in Country A, the velocity of money is constant. Real GDP grows by 5 per cent per year, the money stock grows by 10 per cent per year, and the nominal interest rate is 8 per cent. What is the inflation rate and real interest rate?A.4%, 3%B.5%, 3%C.5%, 4%D.6%, 5%
Question
Suppose in Country A, the velocity of money is constant. Real GDP grows by 5 per cent per year, the money stock grows by 10 per cent per year, and the nominal interest rate is 8 per cent. What is the inflation rate and real interest rate?A.4%, 3%B.5%, 3%C.5%, 4%D.6%, 5%
Solution 1
The inflation rate can be calculated using the Quantity Theory of Money, which states that the growth rate of the money supply plus the growth rate of its velocity equals the inflation rate plus the growth rate of real output. If the velocity of money is constant, its growth rate is zero. Therefore, the inflation rate equals the growth rate of the money supply minus the growth rate of real output.
Given that the money stock grows by 10% per year and real GDP grows by 5% per year, we can substitute these values into the formula:
Inflation rate = 10% - 5% = 5%
The real interest rate can be calculated by subtracting the inflation rate from the nominal interest rate. Given that the nominal interest rate is 8%, we can substitute these values into the formula:
Real interest rate = 8% - 5% = 3%
Therefore, the inflation rate is 5% and the real interest rate is 3%. So, the correct answer is B. 5%, 3%.
Solution 2
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Solution 3
The inflation rate can be calculated using the Quantity Theory of Money, which states that the growth rate of the money supply plus the growth rate of its velocity equals the inflation rate plus the growth rate of real output. If the velocity of money is constant, its growth rate is zero. Therefore, the inflation rate equals the growth rate of the money supply minus the growth rate of real output.
Given that the money stock grows by 10% per year and real GDP grows by 5% per year, we can substitute these values into the formula:
Inflation rate = 10% - 5% = 5%
The real interest rate can be calculated by subtracting the inflation rate from the nominal interest rate. Given that the nominal interest rate is 8%, we can substitute these values into the formula:
Real interest rate = 8% - 5% = 3%
Therefore, the inflation rate is 5% and the real interest rate is 3%. So, the correct answer is B. 5%, 3%.
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