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Consider the model of inflation described by the following

Consider the model of inflation described by the following equation: (M/P) = L(r+ πe,Y)

(a) How is M determined? How is (M/P) determined?

(b) Explain why an decrease in savings would increase the real interest rate. (Hint: Recall the model of Ch. 3.). After the interest rate rises, what will happen to the price level if the money supply is constant?

(c) Explain why an increase in labor would increase output. After output rises what will happen to the price level if the money supply is constant?

(d) If you were Janet Yellen (the chairwoman of the Federal Reserve) what could you do to stabilize the price level in each of these cases?

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