Econ420S10_HW7_Solution - Economics 420 - Spring 2010 Mike...

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Unformatted text preview: Economics 420 - Spring 2010 Mike Aguilar Intermediate Theory: Money, Income & Employment UNC at Chapel Hill HW # 7 Due - 03/29/2010 Instructions : Please explain your answers thoroughly and show all necessary work. State your assumptions carefully. There may be more than one correct solution. Please type your answers whenever possible. Students may work together, but each must submit their own work. The honor code is in effect. Note: Maintain a ceteris paribus assumption when interpreting all shocks. 1. (5pts) Consider an economy with current rates of inflation and unemployment denoted by t and UR t , respectively. The Federal Reserve is attempting to lower inflation, and contemplates contracting the supply of money to achieve this goal. However, the Fed does not want the unemployment rate to rise. It considers using Open Mouth Operations whereby the Fed makes a statement, but takes no action. Specifically, it designs and releases several well-scripted press statements suggesting that they will reduce inflation through contracting the money supply. (a) Will this operation be successful in a Keynesian economy? Explain your claim. (b) Will this operation be successful in a New Classical economy? Explain your claim. Answer: (a) The Phillips curve captures the trade-off between inflation and unemployment that the Fed faces. The key for the Fed is to shift the Phillips Curve inward, so that it can reduce inflation without sacrificing an increae in the unemployment rate. One way to shift the curve is by altering expectations. In the Keynesian model, these expectations are set adaptively. Therefore, the Open Mouth Operations will not be successful becauseadaptively....
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This note was uploaded on 11/02/2010 for the course ECON 420 taught by Professor Hill during the Spring '08 term at UNC.

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Econ420S10_HW7_Solution - Economics 420 - Spring 2010 Mike...

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