Economics Hw need help!?

Question

4. In 2000, the United States was at full employment. The quantity oft money was growing at 8.3 percent a year, the nominal interest rate was 9.5 percent a year, real GDP grew at 5 percent a year, and the inflation rate was 3.1 per- cent a year.

a. Calculate the real interest rate.

b. Use the information given along with the quantity theory of money (V=PxY/M) to see whether the velocity of circulation was constant. If it was not constant, how did it change? And if it changed, why might it have changed?

Answer 1

a)

Simplified method

Real interest rate=9.5% - 3.1% = 6.4%

Right method:

Real interest rate=(1+9.5%) / (1+3.1%) = 1.095/1.031≈ 1.0621= +6.21%

b)

Simplified method:

ΔP= +3.1%

ΔY= +5%

ΔM= +8.3%

ΔV=3.1 + 5 - 8.3 = 8.1-8.3 = -0.2%

Right method:

ΔP= +3.1%

ΔY= +5%

ΔM= +8.3%

V=1.031 x 1.05 / 1.083 ≈ 0.9996 = -0.04%

Velocity fell (may be due to lower inflation or relatively low interest rates, or technological break-downs, or distrust to banks/currency drains/shadow economy, etc.)

But anyway velocity haven't fell too seriously.