Principles of Macroeconomics
6th Edition
ISBN: 9780073518992
Author: Robert H. Frank, Ben Bernanke Professor, Kate Antonovics, Ori Heffetz
Publisher: McGraw-Hill Education
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Chapter 12, Problem 5P
(a)
To determine
Explain what happens to money demand during the Christmas season.
(b)
To determine
Explain what happens to nominal interest rate if the Fed does not take any action.
(c)
To determine
Explain what happens to money supply if the nominal interest rate remains unchanged.
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Suppose the economy is in long-run equilibrium with GDP approaching $23T and the unemployment rate is approaching 4%. Now, let's say that the Fed has decided to decrease the money supply by 6%! The Fed proposes this move by raising the Prime Rate from the current 3.25 to 4.00 and to sell a new trunk or class of 30-year Treasury Bonds. This was not expected! What might be the short and long run effects on the economy as a whole if this were to take place? What happens to the inflation rate? What happens with unemployment? Like I said, this was actually expected that the Fed might take some sort of constriction action to stave off reduce inflation and to strengthen the money supply. However, President Biden, Congress and the Treasury Department had hoped for no contraction of the money supply until 2023.
The following table gives the quantity of money demanded at various price levels (P), the money demand schedule.
In the following table, fill in the column labeled Value of Money.
Quantity of Money Demanded
Price Level (P)
Value of Money (1/P)
1.00
1.00
(Billions of dollars)
2.0
1.33
0.75
2.00
0.50
4.00
0.25
2.5
4.0
8.0
ما
Now consider the relationship between the quantity of money that people demand and the price level. The lower the price level, the less
required to complete transactions, and the more money people will want to hold in the form of currency or demand deposits.
money
1. For each of the following questions, draw the Money Demand curve (MD) and Money
Supply curve (MS) and label the equilibrium interest rate as i*. Also show how the MS-
MD graph changes due to the given events and as a result how the equilibrium interest
rate changes. (In your answer you should clearly state and show what happens to the MS
and MD curves and also what happens to the interest rate).
a) The Fed lowers the RRR
b) Taxes decrease
Chapter 12 Solutions
Principles of Macroeconomics
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- Consider the following scenario: a. In Argentina, the central bank needs to determine by how much to increase the money supply next year. Suppose they estimate an increase in the overall economic activity (real GDP) of 2.5% percent and have a target inflation rate of 4%. The velocity of money has been observed to be constant over the past many years. By what level should the central bank change the money supply to achieve its inflation target? b. Next year, the central bank of Argentina wishes to reduce inflation to 2 percent, and estimates an increase in real GDP by 1.5 percent. What should be the change in the money supply? c. What is an "inflation tax", and how might it explain the creation of inflation by a central bank?arrow_forwardOn the following graph, use the grey point (star symbol) to indicate the equilibrium interest rate and quantity of money that would result from this lack of intervention. Suppose the Fed wants to keep 2014 interest rates at their 2013 level. On the previous graph, place the green line (triangle symbols) to indicate the new money supply curve if the Fed follows this policy. Then use the black point (plus symbol) to indicate the equilibrium interest rate and quantity of money in this case. Because , most central banks set monetary policy aimed at targeting a specific .arrow_forwardIn the following table, fill in the column labeled Value of Money. Quantity of Money Demanded Price Level (P) Value of Money (1/P) (Billions of dollars) 1.00 2.0 1.33 2.5 0.50 2.00 4.0 4.00 1.00 8.0 2.00 Now consider the relationship b required to complete transactions, and the the quantity of money that people demand and the price level. The lower the price level, the money people will want to hold in the form of currency or demand deposits. money Assume that the Federal Reserve initially fixes the quantity of money supplied at $4 billion. Use the orange line (square symbol) to plot the initial money supply (MS1) set by the Fed. Then, referring to the previous table, use the blue connected points (circle symbol) to graph the money demand curve. VALUE OF MONEY 1.25 1.00 0.75 0.50 0.25 0 0 1 2 3 4 5 6 QUANTITY OF MONEY (Billions of dollars) 7 8 MS₁ 1 Money Demand MS 2 ?arrow_forward
- The following graph represents the money market for some hypothetical economy. This economy is similar to the United States in the sense that it has a central bank called the Fed, but a major difference is that this economy is closed (and therefore does not have any interaction with other world economies). The money market is currently in equilibrium at an interest rate of 3% and a quantity of money equal to $0.4 trillion, designated on the graph by the grey star symbol. image 1 INTEREST RATE (Percent) 5.0 45 9 4.0 3.5 3.0 25 20 15 1.0 0 Money Demand 01 Money Supply 02 0.3 0.4 0.5 MONEY (Trillions of dollars) 0.6 0.7 08 4- New MS Curve New Equilibrium Suppose the Fed announces that it is raising its target interest rate by 75 basis points, or 0.75 percentage points. To do this, the Fed will use open- market operations to the public. the money byarrow_forwardIf money demand is unstable, the Fed may prefer to target interest rates rather than the money supply itself. When the Fed follows an interest-rate-targeting policy, “Fed watchers” in financial markets and the media typically look to changes in short-term interest rates rather than changes in the money supply to gauge the Fed’s intentions. Graph the three-month Treasury bill interest rate (i.e., the 3-Month Treasury Bill: Secondary Market Rate) and the unemployment rate, using annual data since 1961. If changes in monetary policy are reflected primarily by changes in the short-term interest rate, what relationship would you expect to see between these two variables? Does this relationship hold up in the data?arrow_forwardThe Quantity Theory of Money (QTM) states that ______. Note: the blank represents an entire phrase, not one word. (a) In the long run, an increase in the money supply will generate an equivalent increase in the velocity of money. (b) In the long run, an increase in the money supply will generate an equivalent increase in real GDP. (c) In the long run, an increase in the velocity of money will generate an equivalent increase in the price level. (d) In the long run, an increase in the money supply will generate an equivalent increase in the price level.arrow_forward
- Fill in the Value of Money column in the following table. Quantity of Money Demanded (Billions of dollars) Price Level (P) Value of Money (1/P) 1.00 1.5 1.33 2.0 2.00 3.5 4.00 7.0 Now consider the relationship between the price level and the quantity of money that people demand. The lower the price level, the money the typical transaction requires, and the money people will wish to hold in the form of currency or demand deposits. Assume that the Fed initially fixes the quantity of money supplied at $3.5 billion. Use the orange line (square symbol) to plot the initial money supply (MS,) set by the Fed. Then, referring to the previous table, use the blue connected points (circle symbol) to graph the money demand curve.arrow_forwardThe following graph represents the money market in a hypothetical economy. As in the United States, this economy has a central bank called the Fed, but unlike in the United States, the economy is closed (that is, the economy does not interact with other economies in the world). The money market is currently in equilibrium at an interest rate of 3% and a quantity of money equal to $0.4 trillion, as indicated by the grey star. 5.0 Money Demand New MS Curve ++ New Equilibrium 1:07 PM 4/29/2022 INTEREST RATE (Percent) 4.5 4.0 3.5 3.0 2.5 2.0 1.5 L L' O 0arrow_forwardLike many other investors you are a “Fed Watcher” who constantly monitors any actions taken by the Fed to revise monetary policy. You believe that 3 key factors affect interest rates. Assume that the most important factor is the Fed’s monetary policy. The second most important factor is the state of the economy, which influences the demand for loanable funds. The third factor is the level of inflation, which also influences the demand for loanable funds. Because monetary policy can affect interests, it affects economic growth as well. By controlling monetary policy, the fed influences the prices of all types of securities. The following information is available to you: Economic growth has been consistently strong over the past few years but is beginning to slow down. Unemployment is as low as it has been in the past decade, but it has risen slightly over the past two quarters. Inflation has been about 5 percent annually for the past few years The dollar has been strong Oil…arrow_forward
- 4. Changes in the money supply The following graph represents the money market in a hypothetical economy. This economy has a central bank, similar to the Bank of Canada, called the Fed. Unlike in Canada, the economy is closed (that is, the economy does not interact with other economies in the world). The money market is currently in equilibrium at an interest rate of 2.5% and a quantity of money equal to $0.4 trillion, as indicated by the grey star. INTEREST RATE (Percent) 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0 Money Demand 0.1 Money Supply 0.3 0.4 0.5 0.6 MONEY (Trillions of dollars) 0.2 0.7 4 0.8 New MS Curve New Equilibrium (? Suppose the Fed announces that it is lowering its target interest rate by 75 basis points, or 0.75 percentage point. To do this, the Fed will use open- market operations to the money by the public.arrow_forward6. Changes in the money supply The following graph represents the money market for some hypothetical economy. This economy is similar to the United States in the sense that it has a central bank called the Fed, but a major difference is that this economy is closed (and therefore does not have any interaction with other world economies). The money market is currently in equilibrium at an interest rate of 3.5% and a quantity of money equal to $0.4 trillion, designated on the graph by the grey star symbol. INTEREST RATE (Percent) 5.5 5.0 New MS Curve Money Demand 4.5 4.0 3.5 3.0 2.5 2.0 1.5 0 0.1 0.2 Money Supply 0.3 0.4 0.5 0.6 0.7 0.8 MONEY (Trillions of dollars) New Equilibrium (?) Suppose the Fed announces that it is raising its target interest rate by 50 basis points, or 0.5 percentage points. To do this, the Fed will use open- market operations to the money by the public. Use the green line (triangle symbol) on the previous graph to illustrate the effects of this policy by placing…arrow_forward2. Money supply, money demand, and adjustment to monetary equilibrium The following table gives the quantity of money demanded at various price levels (P), the money demand schedule. In the following table, fill in the column labeled Value of Money. Quantity of Money Demanded Price Level (P) Value of Money (1/P) (Billions of dollars) 1.00 1.00 1.33 0.75 2.00 0.50 4.00 0.25 1.5 2.0 3.5 7.0 Now consider the relationship between the quantity of money that people demand and the price level. The lower the price level, the less required to complete transactions, and the less money people will want to hold in the form of currency or demand deposits. Assume that the Federal Reserve initially fixes the quantity of money supplied at $3.5 billion. Use the orange line (square symbol) to plot the initial money supply (MS₁) set by the Fed. Then, referring to the previous table, use the blue connected points (circle symbol) to graph the money demand curve. moneyarrow_forward
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