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slides07 - More Classical Examples Here are examples to...

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1 More Classical Examples • Here are examples to help you practice problem-solving in the classical setting. • Types of Examples: 1. One-time changes: No growth. - What if … [some change occurs]. What should the Fed do … [to reach a target]. 2. Money growth. Questions about the long run. - What if & What should questions. Other variables growing or not. 3. Money growth. Questions also about the transition. - What if & What should questions. Other variables growing or not. • Note: Many classical questions have numerical answers. You are expected to know which ones. In a test, if there is a numerical answer, full credit requires numbers. • Most graphical illustrations are left as exercise – done in class, if anyone asks. In a test, disagrams and time series sketches may be required. • Answers will be posted after the questions are discussed in class.
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2 Review: Key equations and Assumptions 1. The Nominal interest rate: i = i r + π e 2. The Money market equilibrium condition: General formula: M = f ( i , Y ) P . Quantity theory version: M V ( i ) = Y P . - Use whichever version is most convenient. - Assume L is increasing in Y and decreasing in i. V is increasing in i. - Real output and the real interest rate are exogenous. - Best interpret the quantity theory version as special case of f ( i , Y ) = 1 V ( i ) Y . 3. The Inflation equation: π = g ( M ) g ( Y ) + g ( V ) . • Assumptions about Expected Inflation: - If inflation in the long run= initial inflation: Ignore changes (for simplicity) . - If not, assume gradual adjustment (unspecific) or use specific assumptions given.
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3 Review: The Money-Price Diagram P M M d =f(i,Y)*P or P=M*V(i)/Y M S
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4 Part 1: One-Time Changes 1-1. Suppose initially M, P, Y, and i r are constant, and π e =0, so i=i r . Then the money supply increases by 5%. What happens to M, P, Y, i r , π , i? 1-2. Suppose initially M, P, Y, and i r are constant, and π e =0, so i=i r . Then the money supply decreases by 10%. What happens? (Always: to M, P, Y, i r , π , i? Omit if ‘no change’.) 1-3. Suppose initially M, P, Y, and i r are constant; expected inflation is zero, so i=i r . Then the money supply increases by 5% from one year to the next; in the following year, M decreases by 10%. What happens?
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5 1-4. Suppose initially M, P, Y, and i r are constant, and π e =0, so i=i r .
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