Question: THE EFFECTS OF A PERMANENT DECREASE IN MONEY GROWTH Suppose that the economy can be described by the following three equations: ut - ut-1 =

THE EFFECTS OF A PERMANENT DECREASE IN MONEY GROWTH Suppose that the economy can be described by the following three equations: ut - ut-1 = -0.4(gyt - 3%) Okun’s law pt - pt-1 = -(ut - 5%) Phillips curve gyt = gMt - pt aggregate demand

a. Reduce the three equations to two by substituting g yt from the aggregate demand equation into Okun’s law. Assume initially that u t = u t−1 = 5%, gMt = 13%, and pt = 10%. Now, suppose that this year’s money growth is permanently reduced from 13% in period t1 to 0% in period t and all subsequent periods.

b. Compute the impact on unemployment and infl ation this year and next year.

c. Compute the values of unemployment and infl ation in the medium run.

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