answers3 - University of California, Berkeley Department of...

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University of California, Berkeley ` Fall 2007 Department of Economics ECON 182 Suggested Solutions to Problem Set 3 Problem 1: Interest rates, expectations, and currency valuation (a) This might occur if the actual Fed cut was larger than expected. If people expected a -0.25 change, but the Fed actually made a -0.5 change, then the dollar would depreciate even more after the Fed meeting. (b) This is exactly the opposite case. For example, a -0.5 change is expected but the Fed only delivers a -0.25 change. Then the money supply has increased less than expected. People then revise their valuation of dollar, and the dollar appreciates. (c) This is consistent with case (a). It could also be taken as a signal that the Fed thinks economy is in worse shape than the market had thought, and that future cuts may even be coming. Problem 2: Hyperinflation in Zimbabwe (a) This is possible when money demand decreases. Recall the QTM equation: M/P = kY, where k is the 1/(‘velocity’ of money) (or k is simply money demand). When
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answers3 - University of California, Berkeley Department of...

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