soln4 - However, because expected inflation also falls,...

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Professor S. McCafferty Problem Set #4 Solutions Numerical Problem #7.5: From textbook equation (7.12), we know that: 0 since , = = - = Y Y M M Y Y M M Y η π . The key to understanding this question is to realize that everyone will understand the inflation process, and so M M e = . a.) For this part of the problem, we need to change to , 10 . 0 = e and so: 10 ) 10 . 0 05 . 0 ( ) 150 )(( 01 . 0 ( ) ( 01 . 0 = + = + = e r Y L We also know that P M L = , and so . 30 10 300 = = P b.) In this part of the problem, , 05 . 0 = e and so: 15 ) 05 . 0 05 . 0 ( ) 150 )(( 01 . 0 ( ) ( 01 . 0 = + = + = e r Y L . We also know that P M L = , and so . 20 15 300 = = P This part of the problem is interesting because it forces us to carefully distinguish between changes in the rate of inflation and changes in the level of prices. The slowdown in money growth reduces the inflation rate.
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Unformatted text preview: However, because expected inflation also falls, there is an immediate downward jump in the price level . Analytical Problem 7.4: The key to this problem is to remember that: ) , , ( m e i r Y L M P + = a.) A temporary increase in G makes r increase, and so prices rise . b.) A reduction in e causes prices to fall . c.) A temporary increase in labor supply makes Y increase temporarily, which also causes r to fall. L rises and so prices fall . d.) An increase in m i causes L to rise, and so prices fall . 2...
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soln4 - However, because expected inflation also falls,...

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