Answered: Suppose the central bank announces that…

Economics:

10th Edition

ISBN:9781285859460

Author:BOYES, William

Publisher:BOYES, William

Chapter9: Aggregate Expenditures

Section: Chapter Questions

Problem 8E

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Question

Similar to how the quantity demanded for a good depends on its price, the quantity of money demanded depends on the cost of holding money, or the nominal interest rate (i). In addition to this, the demand for real money balances is also a function of income (Y). Using all of this information, suppose the demand for real money balances takes on the following functional form:

(M/P)dd=500 + 2Y – 9i

The Fisher equation relates the nominal interest rate to the real interest rate (r) and the expected rate of inflation (Eπ) when examining ex-ante (based on forecasts or 'before the event') effects. The equation ( (M/P)dd = 500 + 2Y – 9(Eπ – r)/(M/P)dd = 500 + 2Y – 9(r – Eπ) / (M/P)dd = 500 + 2Y + 9(r + Eπ) / (M/P)dd = 500 + 2Y – 9(r + Eπ) ) is equivalent to the function given for the demand for real money balances.

Suppose the central bank announces that it will increase the money supply in the future, but it does not change the money supply today. Complete the following table with the effects this will have on the following variables.

Expected Inflation	Increase/decrease/no change
Nominal Interest Rate	Increase/decrease/no change
Demand for Real Money Balances	Increase/decrease/no change
Price Level	Increase/decrease/no change

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