**1. ** In the Cagan model, if the money supply is expected to grow at some constant rate *μ* (so that *Em** _{t+s}* =

Interpret this result.

What happens to the price level

*p*when the money supply_{t}*m*changes, holding the money growth rate_{t}*μ*constant?What happens to the price level

*p*when the money growth rate_{t}*μ*changes, holding the current money supply*m*constant?_{t}If a central bank is about to reduce the rate of money growth

*μ*but wants to hold the price level*p*constant, what should it do with_{t}*m*? Can you see any practical problems that might arise in following such a policy?_{t}How do your previous answers change in the special case where money demand does not depend on the expected rate of inflation (so that

*γ*= 0)?

1 Milton Friedman and Anna J. Schwartz, *A Monetary History of the United States, 1867– 1960* (Princeton, NJ: Princeton University Press, 1963); Milton Friedman and Anna J. Schwartz,

2 Stanley Fischer, “Seigniorage and the Case for a National Money,” *Journal of Political Economy* 90 (April 1982): 295–

3 *Mathematical note:* This equation relating the real interest rate, nominal interest rate, and inflation rate is only an approximation. The exact formula is (1 + *r*) = (1 + *i*)*/*(1 + *π*). The approximation in the text is reasonably accurate as long as *r, i*, and *π* are relatively small (say, less than 20 percent per year).

4 Robert B. Barsky, “The Fisher Effect and the Forecastability and Persistence of Inflation,” *Journal of Monetary Economics* 19 (January 1987): 3–

5 See, for example, **Chapter 2** of Alan Blinder, *Hard Heads, Soft Hearts: Tough- Minded Economics for a Just Society* (Reading, MA: Addison Wesley, 1987).

6 Robert J. Shiller, “Why Do People Dislike Inflation?” in *Reducing Inflation: Motivation and Strategy*, edited by Christina D. Romer and David H. Romer (Chicago: University of Chicago Press, 1997), 13–

7 The movie made about forty years later hid much of the allegory by changing Dorothy’s slippers from silver to ruby. For more on this topic, see Henry M. Littlefield, “The Wizard of Oz: Parable on Populism,” *American Quarterly* 16 (Spring 1964): 47–*Journal of Political Economy* 98 (August 1990): 739–

8 For an examination of this benefit of inflation, see George A. Akerlof, William T. Dickens, and George L. Perry, “The Macroeconomics of Low Inflation,” *Brookings Papers on Economic Activity* 1996, no. 1: 1–**Chapter 12** in an FYI box on The Liquidity Trap.

9 For more on these issues, see Thomas J. Sargent, “The End of Four Big Inflations,” in *Inflation*, edited by Robert Hall (Chicago: University of Chicago Press, 1983), 41–*Weltwirtschaftliches Archiv* 122 (April 1986): 1–

10 The data on newspaper prices are from Michael Mussa, “Sticky Individual Prices and the Dynamics of the General Price Level,” *Carnegie- Rochester Conference on Public Policy* 15 (Autumn 1981): 261–

11 This model is derived from Phillip Cagan, “The Monetary Dynamics of Hyperinflation,” in *Studies in the Quantity Theory of Money*, edited by Milton Friedman (Chicago: University of Chicago Press, 1956): 25–

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