The effects of a permanent decrease in the rate of nominal money growth
Suppose that the economy can be described by the following three equations:
a. Reduce the three equations to two by substituting gyt from the aggregate demand equation into Okun's law. (Okun's law was presented in Chapter 2.) Assume initially that ut = ut-1 = 5%, gmt = 13%, and πt = 10%.
b. Explain why these values are consistent with the statement "Inflation is always and everywhere a monetary phenomenon." Now suppose that money growth is permanently reduced from 13% to 3%, starting in year t.
c. Compute (using a calculator or a spreadsheet program) unemployment and inflation in years t, t + 1,.... t + 10.
d. Does inflation decline smoothly from 10% to 3%? Why or why not?
e. Compute the values of the unemployment rate and the inflation rate in the medium run.
f. Is the statement that "Inflation is always and everywhere a monetary phenomenon" a statement that refers to the medium run or the short run?