Explain why inflation varies

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Assume a hypothetical economy in which the velocity is constant at 2 and real GDP is always at a constant potential of $4,000. Suppose the money supply is $1,000 in the first year, $1,100 in the second year, $1,200 in the third year, and $1,300 in the fourth year. Using the equation of exchange, compute the price level in each year. Compute the inflation rate for each year. Explain why inflation varies, even though the money supply rises by $100 each year. If the central bank wanted to keep inflation at zero, what should it have done to the money supply each year? If the central bank wanted to keep inflation at 10% each year, what money supply should it have targeted in each year?

Reference no: EM13978606

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