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Answers PS10 - Econ 3140-2 Fall 2009 Problem Set 10 Answer...

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Econ 3140-2 Fall 2009 Problem Set 10 Answer Key 1. (a) 2 : 40 (b) 0 : 3 (c) 240 (d) 482 2. (a) Banks in good condition can take out a primary credit discount loan, without additional supervision from the Fed. Banks that are not in good condition may be allowed to take out a secondary credit discount loan, which carries a higher interest rate and closer supervision by the Fed. (b) 1. Do nothing, let P adjust. 2. Increase the money supply, shifting LM to the right. 3. Do nothing if the IS shift was anticipated; could increase money supply if the IS shift was unanticipated and the money supply change would be unanticipated; or you could inform people about the IS shock, so they would build it into their expectations. (c) The Taylor rule is a rule for monetary policy that allows the Fed to respond to the state of the economy. The rule sets the nominal Fed funds rate as the sum of the in°ation rate over the past year plus 2% plus one half times the percentage deviation of output from its full-employment level plus one half times the amount by which in°ation over the past year exceeds 2% . If in°ation were 4% and output were 1% below its full-employment level, the nominal Fed funds rate would be: 0 : 04 + 0 : 02 + [(0 : 5) ( ° 0 : 01)] + [(0 : 5) (0 : 04 ° 0 : 02)] = 0 : 065 = 6 : 5% : 3. To examine the Taylor rule, we± ll use the classical model with misperceptions. (a) An increase in money demand causes the aggregate demand curve to shift down and to the left, reducing the price level and in°ation and decreasing output, if the money supply is unchanged. In response to these changes in output and in°ation, the Taylor rule decreases the nominal Fed funds rate, which means the money supply is increased. This shifts the aggregate demand curve up and to the right and helps stabilize the economy. (b) A temporary increase in government purchases causes the aggregate demand curve to shift up and to the right, increasing the price level and in°ation and increasing output, if the money supply is unchanged. In response to these changes, the Taylor rule increases the nominal Fed funds rate, which means the money supply is decreased. The decrease in the money supply shifts the aggregate demand curve down and to the left and helps stabilize the economy.
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