Show all working including original formula used to...

Show all working including original formula used to calculate answers: 1) If the inflation rate is 3% and the nominal interest rate is 5% ad the money growth rate decreases to 2%, then we would expect the inflation rate to be? 2) If the expected inflation rate is 3% and the actual inflation rate is 5%, then the unexpected inflation rate is? 3) If the nominal interest rate is 5% and the expected inflation rate is 2%, then the expected real rate of interest is? 4) If the interest rate is 5% and the inflation rate is 3%, then the real rate of return on money is?

Transcript

00:01 So here we're going to be working with something called the equation of exchange, which says that mv is equal to p y.

00:07 Now, some of these are pretty familiar, right? m is equal to money.

00:12 P is equal to prices.

00:15 Y is equal to output.

00:18 V is equal to velocity, which is the weird one, right? velocity is how much money is used.

00:24 So py is the stuff bought, right? it's how much the economy produced at current prices.

00:33 So it's the total value of stuff bought.

00:36 This is equal to stuff spent, right? it's the total amount of money used, m, times how many times that money was used.

00:43 So if there was a million dollars in the economy, and each piece of money had a velocity of two, that is, was used twice.

00:51 There would be $200 million, there'd be $2 million of spending, right? so this has to hold as an accounting identity.

00:57 The other thing that we can think about here is that the price, in the long run, we think of the change in money growth as reflecting change in prices, which was what we call inflation, right? this is what we call the quantity theory of money, right? that in the long run, the prices reflect how valuable money is.

01:24 The more money you print, the less valuable it will be.

01:27 The quantity theory of money says that printing money is what determines inflation.

01:31 If you print 10 % more money, the money will become worth 10 % less.

01:36 Finally, we've got a lot of stuff here.

01:38 We have the fisher equation, which says that the real interest rate is equal to the nominal rate minus expected inflation.

01:48 So the idea here being that, look, if someone gives you, makes you a loan at 10%, but then the prices go of everything go up by 10%, right? and 10, your purchasing power hasn't changed, zero, right? you get 10 % interest.

02:05 Everything costs 10 % more.

02:07 All you've done is broken even.

02:08 So these are all the formulas we're going to need here, right? so for a, we're told that inflation is equal to 3%.

02:17 Nominal interest rate is 5%, but money growth, the change in money goes to to 2%, right? so this is a bit of a bait here.

02:34 We don't need the nominal interest rate.

02:36 The idea is that we invoke the quantity theory that says that inflation will reflect the growth in the money supply...