25. Suppose the liquidity preference function is given by
Use the money demand equation, along with the following table of values, to calculate the
velocity for each period.
Y (in billions)
20. Much of the U.S. government debt is held by foreign investors as treasury bonds and bills.
How do fluctuations in the dollar exchange rate affect the value of that debt held by
As the dollar becomes stronger (worth more) relative to a fore
e. The Fed reduces reserve requirements.
A decrease in required reserves shifts the demand for reserves line to the left, at any given
interest rate. The result is that the fed funds rate decreases, and NBR and BR remain
f. The Fed reduces rese
their power to attain their goals, as their reputation is at stake. Even if their reputation is not
that important to them, they have an incentive to do their job, since they might be fired
otherwise. When the central bank officials and the general public
ANSWERS TO APPLIED PROBLEMS
18. Calculate the value of the consumption function at each level of income in the table below if
autonomous consumption = 300, taxes = 200, and mpc = 0.9.
Income Y Disposable Income YD Consumption C
Net Tightening of
Net Worth Average
2013:Q2 to 2014:Q1
2012:Q2 to 2013:Q1
ANSWERS TO QUESTIONS
1. Why might a bank be willing to borrow funds from other banks at a higher rate th
b. Households and firms become more optimistic about the economy.
Positive demand shock. This increases autonomous consumption and investment, which
increases aggregate demand. Output and inflation increase in the short run; in the long run,
The real interest rate increases to r = 3. Y = 13.2; C = 10.9; I = 0.1; NX = -1.3.
d. Considering that output, consumption, planned investment, and net exports all decreased
in part (c), why might the Fed choose to increase r ?
The Fed may believe that th
27. As monetary policymakers become more concerned with inflation stabilization, the slope of
the aggregate demand curve becomes flatter. How does the resulting change in the slope of
the aggregate demand curve help stabilize inflation when the economy is
ANSWERS TO DATA ANALYSIS PROBLEMS
1. Go to the St. Louis Federal Reserve FRED database, and find data on real government
spending (GCEC1), real GDP (GDPC1), taxes (W006RC-1Q027SBEA), and the personal
consumption expenditure price index (PCECTPI), a measur
Decit and Change in Federal Reserve
Bond Holdings, 1980 - 2007
Change in Federal Reserve
Bond Holdings, $Bil.
y = 0.0143x + 21.409
R = 0.01846
2. Go to the St. Louis Federal Reserve FRED database, and find data on the personal
consumption expenditure price index (PCECTPI), the unemployment rate (UNRATE), and an
estimate of the natural rate of unemployment (NROU). For the price index, adjust the
21. Suppose the monetary policy curve is given by r = 1.5 + 0.751, and the IS curve is given by Y
= 13 - r.
a. Calculate an expression for the aggregate demand curve.
Y = 11.5 - 0.75.
b. Calculate the real interest rate and aggregate output when the infla
21. Why is it that a decrease in the discount rate does not normally lead to an increase in
borrowed reserves? Use the supply and demand analysis of the market for reserves to explain.
In most cases, the discount rate is set far enough above the fed funds
b. Given your answer to part (a), what is the expected interest rate in this market?
The expected interest rate on a one-year discount bond with face value of $1000 and
current price of $975 is given as i = (1000 - 975)/975 = 0.0256, or 2.56%.
25. The dem
15. If there were no asymmetry in the information that a borrower and a lender had, could a
moral hazard problem still exist?
Yes, because even if you know that a borrower is taking actions that might jeopardize paying
off the loan, you must still stop th
ANSWERS TO QUESTIONS
1. If I can buy a car today for $5,000 and it is worth $10,000 in extra income to me next year
because it enables me to get a job as a traveling salesman, should I take out a loan from
Larry the Loan Shark at a 90% interest
23. What are the advantages and disadvantages of currency boards and dollarization over a
monetary policy that uses only an exchange-rate target?
A currency board has the advantage that the central bank no longer can print money to create
inflation, and s
24. You wish to hire Ron to manage your Dallas operations. The profits from the operations
depend partially on how hard Ron works, as follows.
Profit = $10,000 Profit = $50,000
If Ron is lazy, he will
11. If net exports were not sensitive to changes in the real interest rate, would monetary policy
be more or less effective in changing output?
Monetary policy would be less effective in changing output, since net exports represent a
7. Was money a better store of value in the United States in the 1950s than in the 1970s? Why
or why not? In which period would you have been more willing to hold money?
Because money was losing value at a slower rate (the inflation rate was lower) in the
17. If the Fed sells $2 million of bonds to Irving the Investor, who pays for the bonds with a
briefcase filled with currency, what happens to reserves and the monetary base? Use Taccounts to explain your answer.
Reserves are unchanged, but the monetary b
23. X-Bank reported an ROE of 15% and an ROA of 1%. How well capitalized is this bank?
ROE = ROA EM
0.15 = 0.01 EM
EM = 15 = assets/equity
So equity/assets = 6.66%. This is a well-capitalized bank.
24. Suppose you are the manager of a bank whose $100 bill
coupon payment of zero divided by current price) for a discount bond.
11. If interest rates decline, which would you rather be holding, long-term bonds or short-term
bonds? Why? Which type of bond has the greater interest-rate risk?
You would rather be ho
b. A permanent negative supply shock.
With a permanent negative supply shock, the long-run aggregate supply curve shifts to
the left. This creates a condition in which output is now above potential output, and the
labor market tightens. As inflation and i
ANSWERS TO QUESTIONS
1. Explain why you would be more or less willing to buy a share of Microsoft stock in the
a. Your wealth falls.
Less, because your wealth has declined
b. You expect the stock to appreciate in value.
6. What types of bank regulations are designed to reduce moral hazard problems? Will they
completely eliminate moral hazard problems?
Regulations that restrict banks from holding risky assets directly decrease the moral hazard
of risk taking by the bank.
banks assets are being managed.
10. If a bank doubles the amount of its capital and ROA stays constant, what will happen to ROE?
ROE will fall in half.
11. What are the benefits and costs for a bank when it decides to increase the amount of its bank
federal funds rate should be negative by as much as almost 4%, which is not possible. It
also predicted a significant rise in the federal funds rate in 2011, which did not
c. Based on the results from the 20082009 period, explain the limitati