1. Assume a model where prices and wages are completely flexible, output and the real interest rate are always at the equilibrium level corresponding to full employment, and there is perfect foresight. In this model, examine the dynamic response of the price level (in logs) to a permanent decrease in the rate of growth of money supply. Illustrate your answer. How is your answer affected if equilibrium (full-employment) output is not constant, but grows at a constant rate over time? Assume that the elasticity of money demand with respect to output is constant.

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