HW5 AK - Sonoma State University Department of Economics...

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Sonoma State University ECONOMICS 304 Department of Economics Florence Bouvet Assignment 5-Answer Key Due Date: October 29 th at the beginning of lecture Please turn in your answers on a separate page. 1) a) % Δ M + % Δ V = % Δ P + % Δ Y so 9% + 0 = π + 6% so π = 3% r = i - π = 7% - 3% = 4% b) now 8% + 0 = π + 6% so π = 2% Since the real interest rate is determined by the real side of the economy, r is still 4%. (But the nominal interest rate will become i = r + π = 4% + 2% = 6% 2) Printing money generates seigniorage revenue for the Russian government. In other words, it could print money and use it to pay government workers the back wages it owes them. This method of generating revenue was attractive to the Russian government because the alternatives were difficult: large corporation were refusing to pay their taxes, domestic banks were unable to make big loans to the government, and foreign banks did not trust the government to pay back. a) In the Neoclassical theory, the equilibrium condition that determines the price level is: M s /P=L(r+ ° e , Y). A rise in money supply clearly will lead to a higher price level a month from now. If people anticipate this, then the expected inflation will lower money demand today. To equate real money supply with real money demand, the equilibrium price level will rise today. How much of the price rise happens now versus a month from now depends on how well people anticipate the future monetary policy. b) In the Fisher relation: i= r+ ° e , the rise in expected inflation will cause a rise in the nominal interest rate today. This prediction seems to have been borne out in practice in Russia. 3) How bad is inflation in Zimbabwe? Based on the article below, what is likely to have caused hyperinflation in Zimbabwe? The increase in money supply by the government a) because of the recession triggered by the collapse in agricultural production after the government seized farms. ° no revenues to tax b) debt denominated in US $ needs to be paid but the Zimbabwean dollar has been depreciating against US $, so it has become more and more difficult to pay the national debt.
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By MICHAEL WINES Published: May 2, 2006 The New York Times Ayina Musoni, 58, has taken in lodgers to help with expenses, but she can barely afford food for her family. Correction Appended HARARE, Zimbabwe , April 25 — How bad is inflation in Zimbabwe? Well, consider this: at a supermarket near the center of this tatterdemalion capital, toilet paper costs $417. No, not per roll. Four hundred seventeen Zimbabwean dollars is the value of a single two-ply sheet. A roll costs $145,750 — in American currency, about 69 cents. The price of toilet paper, like everything else here, soars almost daily, spawning jokes about an impending better use for Zimbabwe's $500 bill, now the smallest in circulation.
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