Macroeconomics
10th Edition
ISBN: 9780134896441
Author: ABEL, Andrew B., BERNANKE, Ben, CROUSHORE, Dean Darrell
Publisher: PEARSON
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Chapter 10, Problem 10RQ
To determine
To Explain: The concept of rational expectations and its implications on the ability of a central bank of an economy in using its
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Students have asked these similar questions
Consider the classical AS-AD model with misperceptions. Assume that the economy is initially at its general equilibrium. Now, suppose the central bank considers an increase in the nominal money supply that is not anticipated by households or firms.
a. How does the misperception theory work?
b. Which of the three markets is first affected (labor, goods, or asset market)? Explain and show graphically how this market is affected by an unanticipated increase in the nominal money supply.
c. Use the classical version of the AS-AD model with misperceptions to explain and to show graphically how an unanticipated increase in the nominal money supply affects the short-run equilibrium.
d. Use the classical version of the AS-AD model with misperceptions to explain and to show graphically how an unanticipated increase in the nominal money supply affects the long-run (general) equilibrium.
Consider the classical AS-AD model with misperceptions. Assume that the economy is
initially at its general equilibrium. Now, suppose the central bank considers an increase in the
nominal money supply that is not anticipated by households or firms.
b. How does the misperception theory work?
c.
Which of the three markets discussed in class is first affected (labor, goods, or asset
market)? Explain and show graphically how this market is affected by an unanticipated
increase in the nominal money supply.
Consider the AD-AS model in the following picture. If the original level of
aggregate demand is Ef, what will be the effect of an expansionary monetary
policy that shifts aggregate demand from ADf to ADI?
Price
Pf
Pr
Fig11a
Er
C.
Yr
Real GDP
LRAS
ADr
Ef
I don't know.
SRAS
Ei
ADf
Yf Yi
a. stagflation
b. inflation and unemployment
ADi
d. inflation, but little employment
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- Using the AD-AS model, discuss the money neutrality in the short-run and in thelong-run.arrow_forwarda. Inflation in Theoretica is currently below the target range of its central bank. What does this tell you regarding Theoretica's likely output gap?arrow_forwardIn the basic New Keynesian model, suppose that there is an increase in government spending. • First, suppose that the central bank does nothing (accommodates the shock). Illustrate onthe graphs and explain what will be the effects on inflation and output? • Second, suppose that economy initially has inflation equal to the central bank’s inflationtarget and an output gap of zero. What action do you expect the central bank wouldundertake? Illustrate you answer on the graph and explain. PLEASE SHOW ALL HAND WRITTEN STEPS AND WORK!arrow_forward
- How does high inflation lead to a recession in the country? Explain the role ofthe Government and the Central Bank to address the economic recessionproblem by using appropriate fiscal and monetary policies.arrow_forwardConsider the economy represented in the graph. This economy has been hit by a positive demand shock (represented by point B). Before the shock the economy was at equilibrium (represented by point A). The top graph represents the equilibrium in the goods market, the labour market is depicted in the middle graph, and the bottom graph shows the central bank's monetary rule. r, real interest rate Is w, real wages We n, inflation TL1 IIT A ye B B B y₁ IS MR IS' y, output WS PS N, employment PC y, output Select all the CORRECT statements: The Central Bank will wait up to two periods to understand if the shock is permanent or temporary, before adjusting interest rate. If the demand shock is temporary, once the adjustment process guided by the central bank finishes, the economy will be back at the same output (Yt=ye) and interest rate (rt = rs). At point B there is a positive bargaining gap between the WS-PS which puts pressure on prices to increase. The slope of the Phillips curve (PC) does…arrow_forwardConsider the AS-AD and three-equations models of a closed economy. Consider an economy that starts out in steady state when the central bank decides to make the inflation target more ambitious. Analyse the effects of a decrease in the inflation target from ? to . Explain the mechanisms behind the adjustment to the new steady state.arrow_forward
- In the New Keynesian Model, assume that the goal of The Fed is to keep unemployment as low aspossible. What is the appropriate response to a negative real shock? a.Increase the money supply, shifting DAD to the left b.Buy bonds, shifting DAD to the right c.Sell bonds, shifting DAD to the left d.Decrease the money supply, shifting DAD to the left e.None of the abovearrow_forwardIn the New Keynesian model, how should the central bank change its target interest rate in responseto each of the following shocks? Use diagrams, and explain your results.a. There is a shift in money demand.b. Total factor productivity is expected to decrease in the future.c. Total factor productivity decreases in the present.arrow_forwardThe Russia-Ukraine war triggers a surging of crude oil price to a record high that leads to anegative supply shock of an economy. If the economy is currently at the full-employmentoutput, how does it affect the aggregate price and real output level in the short- and long-runif the central bank does not carry out any stabilization policies? Explain with the aid of anaggregate demand-aggregate supply diagram.arrow_forward
- WHAT THE FISCAL AND MONETAARY POLICIES DID THE USA GOVERNMENT PURSUE TO COMBAT THR FINANCIAL CRISES ON 2008 AND PANDEMIC CRISES IN 2020? AND HOW WOULD YOU MODEL THE EFFECTS OF THESE POLICIES IN IS\LM AND AD\ AS MODELS?arrow_forwardA. What assumptions did Thomas Sargent make when he claimed that inflation is always and everywhere a fiscal phenomenon?" B. Why is it appropriate in the book's short-term model for the author to use the Phillips Curve as an Aggregate Supply curve? Does it capture the working of the labor market as well as an AS curve based, say, on sticky wages? C. Provide an example of the book's short-run model being based on "microfoundations."arrow_forwardIn the basic New Keynesian model, suppose that there is an increase in the future marginal product of capital. Explain your results with the aid of diagrams. Suppose that the central bank keeps the nominal interest rate at its initial value. What will be the effect on current inflation and on output? Suppose that the economy initially faces an increase in anticipated future inflation and a zero output gap. When the shock occurs, what should the central bank do?arrow_forward
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