Microsoft Word - Solution-Chapter-14

# Microsoft Word - Solution-Chapter-14 - Chapter 31 1 Suppose...

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C h a p t e r 3 1 1. Suppose that the Fed is required to keep the inflation rate between 1 percent and 2 percent a year but with no requirement to keep trend inflation at the midpoint of this range. The Fed achieves its target. a. If initially the price level is 100, i. Calculate the highest price level that might occur after 10 years. The highest price level that might occur after 10 years is 100 1.02 10 , which is 121.9. ii. Calculate the lowest price level that might occur after 10 years. The lowest price level that might occur after 10 years is 100 1.01 10 , which is 110.5. iii. What is the range of uncertainty about the price level after 10 years? The range of uncertainty is from 110.5 to 121.9. b. Would this type of inflation goal serve the financial markets well and provide an anchor for inflation expectations? These inflation rates are relatively low so even if they were at their high point, financial markets probably would not be affected by it. These low inflation rates should anchor inflation expectations at a low level. 2. Suppose that the Bank of England decides to follow the Taylor rule. In 2005, the United Kingdom has an inflation rate of 2.1 percent a year and its output gap is 0.3 percent. At what level does the Bank of England set the repo rate (the U.K. equivalent of the federal funds rate)? The Taylor rule sets the repo rate according to REPO = 2 + INF + 0.5( INF 2) + 0.5 GAP . So the repo rate equals 2 + 2.1 + 0.5(2.1 2) + 0.5( 0.3), which is 4 percent. 3. Suppose that the Bank of Canada is following the McCallum rule. The Bank of Canada has an inflation target range of between 1 percent a year and 3 percent a year. The long-term real GDP growth rate in Canada is 2.4 percent a year. If the velocity of circulation of the monetary base is 2, what is the a. Highest growth rate of monetary base that will occur? The McCallum rule sets the growth rate of the monetary base equal to a target inflation rate plus the long-term real GDP growth rate minus the medium-term growth rate of the velocity of circulation of the monetary base. If the Bank of Canada wants to hit an inflation rate target of 3 percent, the growth rate of the monetary base is 3 + 2.4 2, which equals 3.4 percent. b. Lowest growth rate of monetary base that will occur? If the Bank of Canada wants to hit an inflation rate target of 1 percent, the McCallum rule sets the growth rate of the monetary base equal to 1 + 2.4 2, which is 1.4 percent.

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M O N E T A R Y P O L I C Y 2 2 2 4. In Freezone, shown in Figure 14.1, the aggregate demand curve is AD, potential GDP is \$300 billion, and the short-run aggregate supply curve is SASB. a. What are the price level and real GDP? The price level and real GDP are
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Microsoft Word - Solution-Chapter-14 - Chapter 31 1 Suppose...

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