# Economics 305 Problem Assume that a series of inflation rates is 1 percent, 2 percent,

Economics 305Problem Set No. 4 due in class on Friday October 2Dr. Neri1. Assume that a series of inflation rates is 1 percent, 2 percent, and 4 percent, whilenominal interest rates in the same three periods are 5 percent, 5 percent, and 6 percent,respectively. a. What are the ex post real interest rates in the same three periods?b. If the expected inflation rate in each period is the realized inflation rate in theprevious period, what are the ex ante real interest rates in periods two and three?c. If someone makes a loan in period two, based on the ex ante inflation expectationin part b, will he or she be pleasantly or unpleasantly surprised?2. Assume that the demand for real money balance (M/P) is M/P = 0. 6Y -100i, where Y isnational income and i is the nominal interest rate. The real interest rate r is fixed at 3percent by the investment and saving functions. The expected inflation rate equals therate of nominal money growth. a. If Y is 1,000, M is 100, and the growth rate of nominal money is 1 percent, whatmust i and P be?b. If Y is 1,000, M is 100, and the growth rate of nominal money is 2 percent, whatmust i and P be?3. Suppose V is constant, M is growing 5% per year, Y is growing 2% per year, andr = 4. a. Solve for i (the nominal interest rate). b. If the Fed increases the money growth rate by 2 percentage points per year, find i. c. Suppose the growth rate of Y falls to 1% per year. What will happen to inflation ( )?What must the Fed do if it wishes to keep constant?