The previous question assumed that the central bank can really control money growth and velocity growth within
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In this question, the central bank tries to follow nominal GDP targeting so that AD grows at 7% per year. In other words, the central banks tries to set the money growth rate so that velocity growth plus money growth equals 7%. Each year, it responds to that years velocity growth, but the response wont actually kick in until next year. (Think of this as driving a car with loose steering: You steer to the right, but the car only starts moving to the right about 2 seconds later.)
a. Fill in the table below. Notice that in each year, Actual AD = Velocity growth + Money growth. In the first year, the central bank observes velocity growth of 3% and thus targets money growth of 4%. The next year money grows at 4% as targeted, but velocity growth in that year is 1% so actual AD grows at 5%. In Year 2, the central bank observes velocity growth of 1% and thus targets money growth of 6%. Keep going.
b. Every year, the central bank tries to keep AD = 7%, yet it never accomplishes its goal. How do long lags explain this failure?
c. How would this table look if you had followed Friedmans 3 percent money growth rule instead? Dont calculate any numbers just answer verbally: Would the swings tend to be bigger than in the table or smaller?
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