Question about MONEY and Exchange Rates?

Question

Consider a central bank that wants to keep the inflation (the growth rate of the price level) at exactly 2.5% over the next year. The bank’s economists estimate that output growth will lead to an increase in the real demand for liquidity of 1.5%.

a) By how much will the central bank change the money supply to achieve its goal?

b) Briefly explain how the central bank can increase the money supply.




Thanks for helping

Answer 1

a) Assuming money velocity does not change, money supply will have to be expanded by 2.5% + 1.5% = 4.0%.

b) By buying government bonds in the open market or directly from the government.