a. Let's run through some examples of how this might work, in a setting where the Fed wants to keep AD growth stable at 10%. To keep things simple, we will assume that the Fed can control money growth perfectly. We will also assume that a 1% change in money growth causes a 0.5% shock to velocity growth in the same direction. Using these assumptions, fill in the missing values for the following table. For each case:
$AD = Initial \ Velocity \ Shock + Money \ Growth + Velocity \ Shock \ Caused \ by \ Money \ Growth$
Round your answer to the nearest hundredth.
Year 2 money growth: 4.67 %
Year 2 velocity shock: 2.33 %
Year 3 money growth: %
Year 3 velocity shock: %
Year 4 money growth: %
Year 4 velocity shock: %
Year 5 money growth: %
Year 5 velocity shock: %
Year 6 money growth: %
Year 6 velocity shock: %
b. If velocity does tend to move in the direction of money growth, how does this change the Fed's response to economic shocks?
The Fed should take smaller moves in money growth when a shock comes along.
