In the country of Wiknam, the velocity of money is constant. Real GDP grows by 3 percent per year, the money stock grows by 8 percent per year, and the nominal interest rate is 9 percent. What isa. the growth rate of nominal GDP? b. the inflation rate? c. the real interest rate?

a) 8%

b) 5%

c) 4%

Explanation:

Given:

Growth in real GDP = 3%

Growth of money stock = 8%

Nominal interest rate = 9%

Now,

(a) As per Classical Quantity Theory of Money

Money Supply (M) * Velocity (V) = Price level (P) * Real GDP (Y)

also,

Nominal GDP = P * Y

Change in M + Change in V = Change in P + Change in Y

Since,

V = Constant

thus, Change in V = 0

Change in M = Change in P + Change in Y

Change in P + Change in Y = Change in Nominal GDP = Change in M

thus,

Change in Nominal GDP = 8%

(b)

8% = Change in P + Change in Y

8% = Change in P + 3%

Change in P = Inflation Rate = (8 - 3) % = 5%

(c) Real interest rate = Nominal interest rate - Inflation rate

= (9 - 5) %

= 4%