1. In the Country of Wiknam, the velocity of money is constant. Real GDP grows by 5 percent per year, the money stock grows by 14 percent per year, and the nominal interest rate is 11 percent. What is the real interest rate?

Question

2. The goverment raises taxes by $100 billion. If the marginal propensity to consume is 0.6, what happens to the following? Do they rise or fall? By what amounts?

a. Public saving

b. Private saving

c. National saving

d. Investment

K · Accepted Answer

% Change in M + % Change in V = % Change in P + % Change in Y.
i.e, % Change in P = % Change in M + % Change in V – % Change in Y.

% Change in P = 14% + 0% – 5% = 9%.
% Change in P is the inflation rate π. From the Fisher equation, we have
i = r + π,
i is the nominal interest rate and r is the real interest rate. i is given as 11% in the problem, and we just calculated above that π is 9%. Hence, r is 2%