ECN101_PS4_ans_w08 - This Problem Set is not graded ECN101...

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This Problem Set is not graded. ECN101 Problem Set 4 Instructor: Masako Miyanishi Chapter 4 1. When the money market is in equilibrium, the equation = L(r+π e , Y) holds. M s is money supply today, P is price level today, r is the real interest rate today, e is today’s expectation about future inflation rate (expected inflation rate) , and Y is today’s output. a. Suppose that r, e , and Y are fixed. M s rises by 10%. By how many percent does P go up? P rises by 10% as well. b. Suppose that the Fed announces it will increase M s next year (but not today). How does this affect the economy? Does today’s nominal interest rate rise or fall? How about price level today? Money supply is expected to increase next year. People expect higher money growth and higher inflation next year (just as higher money growth today causes higher inflation today). The expected inflation rises. By Fisher effect, the nominal interest rate goes up today. As a result, demand for real money L(.) decreases today. In order for the equilibrium to hold, the real money supply today has to fall. However, the Fed does not change today’s money supply. Thus, today’s price level P rises. Thus, today’s price level depends not only on today’s money supply (quantity theory), but also on the money supply expected in the future. 2. According to the classical theory of money, inflation does not make workers poorer because wages increase: a. faster than the overall price level. b. more slowly than the overall price level. c. in proportion to the increase in the overall price level. d. in real terms during periods of inflation. Answer: c Chapter 5 1. Use the model of the small open economy to predict what would happen to the trade balance (NX), the real exchange rate, and the nominal exchange rate in response to each of the following events. a. A fall in consumer confidence about the future induces consumers to spend less and save more.
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ECN101_PS4_ans_w08 - This Problem Set is not graded ECN101...

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