03 Jun Question Q.1: The real interest rates and real exchanges rates are constant and equal in North Country and
Question
Q.1: The real interest rates and real exchanges rates are constant and equal in North Country and
South Country. The Fisher equation and purchasing power parity hold in both countries. If the
nominal interest rate is 8 percent in North Country and 10 percent in South Country, do you
expect North Country’s nominal exchange rate to appreciate, depreciate, or remain the same?
Explain. [10]
Q.2: In classical macroeconomic theory, the concept of monetary neutrality means that changes
in the money supply do not influence real variables. Explain why changes in money growth
affect the nominal interest rate, but not the real interest rate. Use quantity theory of money and
fisher equation to answer this question. [10]
Q.3: Consider a money demand function that takes the form (M/P)d = Y/3i, where M is the
quantity of money, P is the price level, Y is real output, and i is the nominal interest rate
(measured in percentage points). [10]
a) What is the velocity of money if the nominal interest rate is constant?
b) How will the level of the velocity of money change if there is a permanent (one time)
increase in the nominal interest rate, holding other factors constant?
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