Econ 154a Problem Set 7 Solution

Econ 154a Problem Set 7 Solution - Problem Set 7 Problem 1....

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Problem Set 7 Problem 1 . Endogenous Money Supply 1. Revisit model with exogenous money supply - Analyze the e f ect of an increase in A. Remember that the procedure to evaluate the impacts in the economy consists of the following steps: f rst, determine what happens in the real side of the economy, i.e., what happens to real interest rate; second, determine how the equilibrium in the future asset markets is a f ected; f nally, given the f rst and second steps, evaluate what happens with current asset market equilibrium. Let’s f rst determine what happens to r. Figure 1: Since S d ( r/A,K,G,G f )isa f ected positively by A, the savings increase, so that for each level of r we have now a higher level of savings which is represented by the shift of S to the right. The equilibrium is given by S = I , so the new equilibrium real interest rate decreases, as can be seen in the f gure above. The second step is to determine how the future asset market equilibrium is a f ected. We have that: P f = M s,f L ( Y f ) = M s,f L ( A f F ( K f ( r ) , ) N f ) 1
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S incew ehav eah ighe rlev e lo finv e s tmen t , K f increases, which implies that Y f increases, increasing the demand for future real balances. Since the supply of future real balances is kept constant this implies that P f has to decrease. The intuition for this is that with a higher income in the future period there is a higher demand for real balances but the supply of money
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This note was uploaded on 07/18/2008 for the course ECON 154 taught by Professor Bjoernbruegemann during the Fall '07 term at Yale.

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Econ 154a Problem Set 7 Solution - Problem Set 7 Problem 1....

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