The Effect of an Increase in the Growth Rate of the Money Supply on the Interest Rate

As we have seen, in the long run, the average annual growth rate of real GDP for the United States has been about 3%, and the expected real interest rate on corporate bonds with Aaa ratings has averaged 2.8%. Suppose that the growth rate of velocity is 0%, and the growth rate of real GDP remains unchanged.

a. Use the Fisher equation to determine the value of the nominal interest rate on Aaa bonds if the money supply grows at an annual rate of 6%.

b. What will happen to the nominal interest rate in the long run if the growth rate of the money supply increases to 10%?

a) As, MV =PV %Change in M %Change in V = %Change in Y %Change in P(Inflation Rate) => 6 0 = 3 %Change in P => %Change in P = 3% Real Interest rate Inflation Rate = Nominal Interest Rate => 2.8% 3% = Nominal Interest Rate => Nominal Interest Rate = 5.8% b) If the growth…

e of the money supply increases to 10%. then using Quantity theory of money Inflation Rate will increase to 7% Then Using Fisher equation Nominal Interest Rate will increase to 7% 2.8% = 9.8%