1.1. This chapter is concerned mostly with how monetary policy might be able to return an economy quickly to the Solow growth rate after a shock. But as we aw in Chapter 12's discussion of the quantity theory of money, a market economy has a correction mechanism to return itself slowly to the Solow growth rate after a shock: flexible prices. Let's review the quantity theory, and remember that in the quantity theory, inflation does all of the adjusting. ----+ ----+

Recall that: M + v = Inflation + Real growth

a. Consider the nation ofKydland. Before the ----+

shock to Kydland's economy, M = 10%, v = 3%, real growth = 4%. What is inflation?

b. In Kydland, v falls to 0%, but M stays the same. In the long run, what will inflation equal? What will real growth equal?

c. Consider the nation of Prescottia. Before the FACTS AND TOOLS