Consider Two Countries, Hitech and Lotech

question 34

Essay

Consider two countries, Hitech and Lotech. In Hitech new arrangements for making payments, such as credit cards and ATMs, have been enthusiastically adopted by the population, thereby reducing the proportion of income that is held as real money balances. Over this period no such changes occurred in Lotech. If the rate of money growth and the growth rate of real GDP were the same in Hitech and Lotech over this period, then how would the rate of inflation differ between the two countries? Carefully explain your answer.

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Definitions:

Dividend

Payments made by a corporation to its shareholders, usually as a distribution of profits.

Annual Real Rate

The annual rate of return on an investment, adjusted for inflation, indicating the real purchasing power increase over the investment period.

Holding-Period Return

The total return received from holding an asset or portfolio of assets over a specified period, including interest, dividends, and capital gains.

Interest

The charge for the privilege of borrowing money, typically expressed as an annual percentage rate.