a) Suppose that initially the economy is in a long-run equilibrium with no money growth, no inflation, and πe = 0%. Then, the central bank announces that, starting in the next period (t+1), the money supply will begin growing at 10%/period. What happens in the current period (t)? Show this on the IS/LM and AD/AS graphs. Assume that all adjustments occur instantly so you don’t have to worry about the path that the economy follows from the initial long-run equilibrium to the new long-run equilibrium. Just to be clear, there is no change M in period t.
b) Explain why the increase in i and decrease in M/P in period t make sense from the point of view of individual economic agents.
c) What happens in the next period when the money supply starts growing at 10%/period? Show this using both the IS/LM and AD/AS graphs.
d) Who pays the inflation tax and how? Who collects the inflation tax and how?