Macroeconomics (Fourth Edition)
4th Edition
ISBN: 9780393603767
Author: Charles I. Jones
Publisher: W. W. Norton & Company
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Chapter 12, Problem 8E
(a)
To determine
Inflation shocks and absence of
(b)
To determine
Monetary policy action during the inflation shock.
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An economy's aggregate demand curve (the relationship between short-run equilibrium output and inflation) is described by the equation:Y = 15,000 - 12,000π, where π is the inflation rate. Initially, the inflation rate is 2 percent or π = 0.02. Potential output Yp equals 14,640.Note: Keep as much precision as possible during your calculations. Your final answer for inflation should be accurate to at least two decimal places and output should be accurate to the nearest whole number.a) Find inflation and output in short-run equilibrium.
Inflation : 0%Output : $0
b) Find inflation and output in long-run equilibrium.
Inflation : 0%Output : $0
Show using a graph how the following shocks would affect equilibrium output. (Which
parameters in the Keynesian model change? How does that shift the expenditure
schedule? What happens to output as a result?)
(a) The housing market collapses
(b) Interest rates rise
(c) The US dollar depreciates (gets weaker) relative to the Euro
(d) Consumer confidence rises in Canada (Hint: use one picture to show what happens
to Canada, then another to show how this affects the US economy)
N' (r*)
X
N*
Nd
P*
(a) Current Labour Market
yd
X
(b) Current Goods Market
Ms
M
Md=PL(Y*, r* + i)
Md, Ms
(c) Current Money Market
Chapter 12 Solutions
Macroeconomics (Fourth Edition)
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- In the Friedman-Lucas money surprise model, there is a negative money demand shock. Neither private sector economic agents nor the central bank can observe the shock directly. Assume that the central bank is committed to money growth targeting. 1. How will it affect the labour, goods and money markets? Show graphically. 2. Argue that the shock could result in inefficient outcomes. Explain using diagrams.arrow_forwardRead the following premise carefully and answer the questions specifically and in detail. You must answer the request with the correct information, showing that you understand and can properly apply macroeconomic concepts. Try to address all elements of each question and always express the answers in your own words. Faced with an instability of economic growth caused by a recession or accelerated inflation, the Fed uses the open market operation to increase or decrease the available reserves of commercial banks which, in turn, will affect the amount of money available in the economy . In addition to the open market operation, the Fed has other tools available to promote growth, sustainability, and economic stability in a country. These tools have been used historically; A suitable example was the 2008 mortgage debt crisis. 1. Explain in detail monetary policy, its role and its effects on short and long-term economic fluctuations. Use the aggregate demand and supply model presented in…arrow_forward(a) Suppose that, in a liquidity trap, bank reserves are less liquid than government debt. If the central bank conducts an open market sale of government debt, what will be the effect on the price level? Use a diagram, explain your results. (b) Suppose that there is a decrease in the price of housing, which the central bank judges is a temporary asset price decrease. In the New Keynesian model, determine the central bank's optimal response to this asset price increase, using diagrams. (c) Suppose initially that inflation is at the central bank's target and the output gap is zero. Then, government spending goes up. Determine, with the aid of diagrams, how the degree of price stickiness affects the central bank's optimal response and explain your results.arrow_forward
- Consider the AD-AS model discussed during the lectures. Assume that the aggregate demand curve is given by Y = 8 - 0.5π, that the long run aggregate supply curve is given by Yp = 7, that the short run aggregate supply curve is given by π = π_expect + 0.3(Y - Yp), and that the monetary rule is given by r = 1 + 0.3π. a) What is the economic interpretation behind the aggregate demand curve? Why is it negatively sloped? If you consider point A=(π,Y)=(3, 6.5) and point B=(π,Y)=(5, 5.5), is monetary policy more expansionary in point A, in point B, or neither? Are you referring to the exogenous or to the endogenous stance of monetary policy?arrow_forwardUse the New-Keynesian model with partial sticky prices studied in class to analyse the following shock and policies (use the five-graph diagram to support your answer).a) The Covid-19 pandemic has caused recession in many countries, including the United States, Australia… Analyse the effects of this Covid shock which brings the Australian economy relatively close to the ZLB .b) The Central bank conducted conventional monetary policy to counter the shock. Suppose that due to this monetary policy, the economy is at the ZLB and output is still below potential level. Moreover, due to the intensification of the pandemic with deadly Delta variant, the zero lower bound is binding. Suggest the policy actions to bring output back to potential level.arrow_forwardConsider the AD-AS model discussed during the lectures. Assume that the aggregate demand curve is given by Y=8-0.5 π, that the long run aggregate supply curve is given by Yp=7, that the short run aggregate supply curve is given by π = π_expect + 0.3(Y-Yp), and that the monetary rule is given byr=1+0.3 π. Suppose the economy is suffering a decrease in the potential level of output, due to some ill-designed new regulation. According to the AD- AS model, what is more suitable to offset the subsequent decline in output, an expansionary monetary policy or an expansionary fiscal policy?arrow_forward
- Consider the following scenario. Aggregate output y at date t is specified as follows, Yt = T - nị +ỹ where the trend level of output is represented by g. The central bank's loss function is captured by L= (- k)* +() Where b> 0, and where k > 0 is a given parameter reflecting the normal level of aggregate production or the target level of output. The central bank takes the public's expectations as given. The society loss function is the same as the central bank loss function. Notation: y;: output/production; T: inflation rate; mf: expected inflation rate; L: loss function; 6, k: constant parameters; t: time index. Having considered the scenario above complete the following tasks: a) Explain the economic intuition behind the output function. b) Explain the components and the economic intuition of the loss function. Why is it quadratic? c) Derive the central banks preferred inflation rate and provide an explanation. d) Derive the socially optimal inflation rate and explain.arrow_forwardIn the basic New Keynesian model, suppose that there is an increase in the future marginal product of capital. Explain your results with the aid of diagrams. Suppose that the central bank keeps the nominal interest rate at its initial value. What will be the effect on current inflation and on output? Suppose that the economy initially faces an increase in anticipated future inflation and a zero output gap. When the shock occurs, what should the central bank do?arrow_forwardSuppose the Phillips curve is and the Aggregate Demand curve is Tt = Tt1+3ytot Yt = at 5(πt - 0.02) where at = Ot = 0 in the steady state. (a) Calculate the steady state values of output and inflation in this economy. (b) Calculate the short- and long-run responses of the economy to the following shocks (use a table to report your answers, as well as show them graphically on the AD-AS graph, as well as plot inflation and output against time): (1) A one-time decrease in ot to -0.05. (2) A one-time increase in at to 0.05 (at returns to 0 thereafter). (3) A permanent decrease in the Fed's inflation target from 0.02 to 0.arrow_forward
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