PRINCIPLES OF MACROECONOMICS(LOOSELEAF)
7th Edition
ISBN: 9781260110920
Author: Frank
Publisher: MCG
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Chapter 14, Problem 1P
(a)
To determine
Explain what happens to money demand during the Christmas season.
(b)
To determine
Explain what happens to nominal interest rate if the Fed does not take any action.
(c)
To determine
Explain what happens to money supply if the nominal interest rate remains unchanged.
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Suppose the economy is in long-run equilibrium with GDP approaching $23T and the unemployment rate is approaching 4%. Now, let's say that the Fed has decided to decrease the money supply by 6%! The Fed proposes this move by raising the Prime Rate from the current 3.25 to 4.00 and to sell a new trunk or class of 30-year Treasury Bonds. This was not expected! What might be the short and long run effects on the economy as a whole if this were to take place? What happens to the inflation rate? What happens with unemployment? Like I said, this was actually expected that the Fed might take some sort of constriction action to stave off reduce inflation and to strengthen the money supply. However, President Biden, Congress and the Treasury Department had hoped for no contraction of the money supply until 2023.
Suppose you have the following information on the Fed's and the European Central Bank's (ECB) policy rules:
Fed real interest rate = 0.5x (inflation - 2)
ECB real interest rate = 0.2 x (inflation -2) +1
If the inflation rate is 2 percent in each, what will be the real interest rate in the U.S. and the ECB area?
Real interest rate in the U.S. =%
Real interest rate in the ECB area =
1. For each of the following questions, draw the Money Demand curve (MD) and Money
Supply curve (MS) and label the equilibrium interest rate as i*. Also show how the MS-
MD graph changes due to the given events and as a result how the equilibrium interest
rate changes. (In your answer you should clearly state and show what happens to the MS
and MD curves and also what happens to the interest rate).
a) The Fed lowers the RRR
b) Taxes decrease
Chapter 14 Solutions
PRINCIPLES OF MACROECONOMICS(LOOSELEAF)
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- Economics Suppose that the income elasticity of money demand is 0.4. Nominal interest rates do not change over time. If money supply increases by 20% every year, while real income only increases by 1%, what is the inflation rate?arrow_forwardConsider the following scenario: a. In Argentina, the central bank needs to determine by how much to increase the money supply next year. Suppose they estimate an increase in the overall economic activity (real GDP) of 2.5% percent and have a target inflation rate of 4%. The velocity of money has been observed to be constant over the past many years. By what level should the central bank change the money supply to achieve its inflation target? b. Next year, the central bank of Argentina wishes to reduce inflation to 2 percent, and estimates an increase in real GDP by 1.5 percent. What should be the change in the money supply? c. What is an "inflation tax", and how might it explain the creation of inflation by a central bank?arrow_forwardThe following graph represents the money market for some hypothetical economy. This economy is similar to the United States in the sense that it has a central bank called the Fed, but a major difference is that this economy is closed (and therefore does not have any interaction with other world economies). The money market is currently in equilibrium at an interest rate of 3% and a quantity of money equal to $0.4 trillion, designated on the graph by the grey star symbol. image 1 INTEREST RATE (Percent) 5.0 45 9 4.0 3.5 3.0 25 20 15 1.0 0 Money Demand 01 Money Supply 02 0.3 0.4 0.5 MONEY (Trillions of dollars) 0.6 0.7 08 4- New MS Curve New Equilibrium Suppose the Fed announces that it is raising its target interest rate by 75 basis points, or 0.75 percentage points. To do this, the Fed will use open- market operations to the public. the money byarrow_forward
- 2) Explain and show graphically: a) What would you expect to happen to the money demand curve during the Christmas season? b) With no Fed intervention, what would happen to the interest rates. c) In fact, interest rates do not change around Christmas due to Fed policy. How does the Fed ensure interest rates remain stable during Christmas?arrow_forwardSuppose the economy begins at full employment. Label this starting point as point "1." Then, suppose that, due to increased instability in the financial markets, a decrease in investor and consumer confidence occurs. Show the effects on your graph and label the new equilibrium point "2." Lastly, suppose the Federal Reserve wants the economy to return to full-employment as quickly as possible. Should the Fed intervene? If so, show the impact of successful monetary policy on your graph. Label this new equilibrium point "3."arrow_forwardExplain the relationship between the effectiveness of monetary policy and the interest elasticity of money demand. Will the monetary policy be more or less effective the higher the interest elasticity of money demand? Explain.arrow_forward
- On the following graph, use the grey point (star symbol) to indicate the equilibrium interest rate and quantity of money that would result from this lack of intervention. Suppose the Fed wants to keep 2014 interest rates at their 2013 level. On the previous graph, place the green line (triangle symbols) to indicate the new money supply curve if the Fed follows this policy. Then use the black point (plus symbol) to indicate the equilibrium interest rate and quantity of money in this case. Because , most central banks set monetary policy aimed at targeting a specific .arrow_forwardIf money demand is unstable, the Fed may prefer to target interest rates rather than the money supply itself. When the Fed follows an interest-rate-targeting policy, “Fed watchers” in financial markets and the media typically look to changes in short-term interest rates rather than changes in the money supply to gauge the Fed’s intentions. Graph the three-month Treasury bill interest rate (i.e., the 3-Month Treasury Bill: Secondary Market Rate) and the unemployment rate, using annual data since 1961. If changes in monetary policy are reflected primarily by changes in the short-term interest rate, what relationship would you expect to see between these two variables? Does this relationship hold up in the data?arrow_forward2. The theory of liquidity preference and the downward-slopingaggregate demand curve The following graph shows the money market in a hypothetical economy. The central bank in this economy is called the Fed. Assume that the Fed fixes the quantity of money supplied. Suppose the price level decreases from 90 to 75. Shift the appropriate curve on the graph to show the impact of a decrease in the overall price level on the market for money. 12 Money Supply 10 Money Demand Money Supply MD1 2 MD2 10 20 30 40 50 60 MONEY (Billions of dollars) INTEREST RATE (Percent)arrow_forward
- Fill in the Value of Money column in the following table. Quantity of Money Demanded (Billions of dollars) Price Level (P) Value of Money (1/P) 1.00 1.5 1.33 2.0 2.00 3.5 4.00 7.0 Now consider the relationship between the price level and the quantity of money that people demand. The lower the price level, the money the typical transaction requires, and the money people will wish to hold in the form of currency or demand deposits. Assume that the Fed initially fixes the quantity of money supplied at $3.5 billion. Use the orange line (square symbol) to plot the initial money supply (MS,) set by the Fed. Then, referring to the previous table, use the blue connected points (circle symbol) to graph the money demand curve.arrow_forwardThe following graph represents the money market in a hypothetical economy. As in the United States, this economy has a central bank called the Fed, but unlike in the United States, the economy is closed (that is, the economy does not interact with other economies in the world). The money market is currently in equilibrium at an interest rate of 3% and a quantity of money equal to $0.4 trillion, as indicated by the grey star. 5.0 Money Demand New MS Curve ++ New Equilibrium 1:07 PM 4/29/2022 INTEREST RATE (Percent) 4.5 4.0 3.5 3.0 2.5 2.0 1.5 L L' O 0arrow_forwardBegin with the money market in equilibrium. What would happen to the money supply function if the Federal Reserve conducted an open market purchase, reduced the discount rate, and increased quantitive easing? What would happen to the money demand function if the Federal Reserve conducted an open market purchase, reduced the discount rate, and increased quantitive easing? What would happen to nominal interest rates in the economy if the Federal Reserve conducted an open market purchase, reduced the discount rate, and increased quantitive easing? What would happen to the quantity of money in the economy if the Federal Reserve conducted an open market purchase, reduced the discount rate, and increased quantitive easing?arrow_forward
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