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# CH4 - Import Settings Base Settings Brownstone Default...

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Import Settings: Base Settings: Brownstone Default Information Field: Level Information Field: Sub Topic Information Field: Topic Highest Answer Letter: D Multiple Keywords in Same Paragraph: No Chapter: CH4 Instruction: Name: __________________________ Date: _____________ Short Answer 1. Assume that a series of inflation rates is 1 percent, 2 percent, and 4 percent, while nominal interest rates in the same three periods are 5 percent, 5 percent, and 6 percent, respectively. a. What are the ex post real interest rates in the same three periods? b. If the expected inflation rate in each period is the realized inflation rate in the previous period, what are the ex ante real interest rates in periods two and three? c. If someone makes a loan in period two, based on the ex ante inflation expectation in part b, will he or she be pleasantly or unpleasantly surprised? Ans: a. 4 percent; 3 percent; 2 percent b. 4 percent; 4 percent c. He or she will be unpleasantly surprised. Topic: Numerical Problems

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2. Assume that the demand for real money balance ( M / P ) is M / P = 0.6 Y – 100 i , where Y is national income and i is the nominal interest rate. The real interest rate r is fixed at 3 percent by the investment and saving functions. The expected inflation rate equals the rate of nominal money growth. a. If Y is 1,000, M is 100, and the growth rate of nominal money is 1 percent, what must i and P be? b. If Y is 1,000, M is 100, and the growth rate of nominal money is 2 percent, what must i and P be? Ans: a. i = 4 percent, P = 1/2 b. i = 5 percent, P = 1 Topic: Numerical Problems 3. Consider two countries, Hitech and Lotech. In Hitech new arrangements for making payments, such as credit cards and ATMs, have been enthusiastically adopted by the population thereby reducing the proportion of income that is held as real money balances. Over this period no such changes occurred in Lotech. If the rate of money growth and the growth rate of real GDP were the same in Hitech and Lotech over this period, then how would the rate of inflation differ between the two countries? Carefully explain your answer.
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