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Imagine, now, you to definitely inflationary requirement was no, p e = 0, so that the MM( p age = 0) bend is applicable

Imagine, now, you to definitely inflationary requirement was no, p e = 0, so that the MM( p age = 0) bend is applicable

Goods market and money market equilibrium implies that we achieve equilibrium E where money supply is M/p0 and real and nominal interest rates are equal to each other at i0 = r0. We can now trace out the consequences of an exogenous increase in inflationary expectations. By raising inflationary expectations to some positive amount, p e > 0, the MM curves shifts down to MM( p e >0). The new equilibrium rate of real interest, rstep one, is at point F in Figure 13, where MM( p e >0) and YY intersect. However, as now i = r + p e , then a “wedge” of size p e is created between the old MM curve and the new one: the new real rate r1 is read off the intersection of YY and the new MM curve (point F) and the new nominal rate i1 is read off the top curve MM( p e =0) at the same level of money supply (point G). Continue reading “Imagine, now, you to definitely inflationary requirement was no, p e = 0, so that the MM( p age = 0) bend is applicable”