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ps6 - Economics 202 Principles of Macroeconomics Problem...

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Economics 202 Name: __________________________ Principles of Macroeconomics Professor Melick Problem Set #6 Due Friday February 29, 2008 For this assignment you will need to access a spreadsheet on the course web page. The spreadsheet contains the following series taken from the St. Louis Fed's FRED® website and converted (where necessary) to a quarterly frequency by using the last month in the quarter. Quarter, in the form YYYY.Q M2 = M2 Money Stock - Seasonally Adjusted P = Implicit GDP Deflator Y = Real GDP, Chained 2000 Dollars 3-Month = 3-Month Treasury Bill Rate - Secondary Market OwnRate = M2 Own Rate – Average interest rate paid on deposits in M2 . 1. Recalling that nominal GDP is simply the product of the GDP deflator (divided by 100) and real GDP (that is P Y ), you can now easily calculate income velocity for M2. Attach a plot that has a vertical scale running from 1.5 to 2.5 and comment on whether it appears to be a constant as assumed by some versions of the quantity theory. How does your plot compare to Figure 7.1 in Abel and Bernanke? 2. Other adherents of the quantity theory acknowledge that velocity is not constant, but that it is predictable. They argue that as the opportunity cost of holding money increases so should velocity. One measure of the opportunity cost of holding money is the interest rate foregone by holding money instead of an asset that pays a higher rate of interest. The last series in the spreadsheet measures the weighted-average interest rate paid on deposits that are included in M2 (called the “own rate”), while we also have data on the rate paid on holding 3-month U.S. Treasury bills. Calculate an opportunity cost series by subtracting the own rate from the Treasury bill rate. Plot this opportunity cost and M2 income velocity on the same chart from 1993 to the present, putting M2 velocity on the primary or left scale (use a scale of 1.8 to 2.2) and putting the opportunity cost on the right scale (use a scale of 0 to
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