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In the second equation, M/P is the real money supply in the economy, L1 is the transaction demand for money and L2 is the speculative demand for money.
Now, inflation rate is basically an increase in the price levels of an economy. It can also be stated as the difference between the nominal money growth and the normal output growth. Basically when the inflation rate in an economy rises, the inflation rate becomes higher than the nominal money growth which is called a negative real money growth. This leads to a rise in the nominal interest rates and with the given inflation rate it translates into a rise in the real rate of interest as well...
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