a
To show:Effect on IS and LM curve due to decrease in the expected future real interest rate.
a
Explanation of Solution
A decrease in expected future interest rates will cause the IS curve to shift to the right. It will also cause the LM curve to shift downwards. Since expectations of future interest rates will affect current variables, the LM curve would shift downwards in much the same way as it would under monetary expansion. The IS curve will shift to the right, causing output to increase and the current interest rate to decrease.
Introduction:
IS curve is a graphical representation of goods
LM curve is a graphical representation of
b)
To show:Effect on IS and LM curve due to an increase in the current real policy interest rate
b)
Explanation of Solution
Increasing the current money supply would shift the LM curve downwards. If the expectations of financial market participants do not change, the IS curve will remain the same and output won't change by much. If people expect the future interest rates to change, the IS curve right shift to the right, increasing output by a significant amount.
Introduction:
IS curve is a graphical representation of goods market equilibrium showing combination of interest rate and output level.
LM curve is a graphical representation of money market equilibrium showing combination of interest rate and output level.
c)
To know:Effect on IS and LM curve due to an increase in expected future taxes.
c)
Explanation of Solution
An increase in future taxes will shift the IS curve to the left. The current output will decrease as consumers will have less disposable income to spend on consumption. This will lead to a lower level of output.
Introduction:
IS curve is a graphical representation of goods market equilibrium showing combination of interest rate and output level.
LM curve is a graphical representation of money market equilibrium showing combination of interest rate and output level.
d)
To find:Effect on IS and LM curve due to decrease in expected future income.
d)
Explanation of Solution
A decrease in expected future income will have the same effect as in part (c). The IS curve will shift to the left and lead to a decrease in consumption. Again, a decrease in future income will cause consumers to have less disposable income, leading to a lower level of output.
Introduction:
IS curve is a graphical representation of goods market equilibrium showing combination of interest rate and output level.
LM curve is a graphical representation of money market equilibrium showing combination of interest rate and output level.
Want to see more full solutions like this?
Chapter 16 Solutions
Macroeconomics, Student Value Edition Plus MyLab Economics with Pearson eText -- Access Card Package (7th Edition)
- The risk-free rate is 4.8%, and expected inflation is 3.2%. If inflation expectation such that future expected inflation rises to 4.5%, what will the new risk-free rate bearrow_forward1 Inflation in the period t in the economy is described by the following function Tt -0.3 + 0.06u, + T where T; - inflation in the period t, ut - unemployment in the period t. Inflation expectations are formed adaptively: T = 0.7Tt-1 + 0.37_1, where T is the expected inflation in the period t. Let's assume that initially, in the time period t is equal to TO reduction of the inflation rate to the level of 0.05, starting from the year t: unemployment rate in year t = 0 and in year t = 1. 0, the inflation rate coincides with the level of inflationary expectations and T = 0.1. The Central Bank is conducting a policy of permanent (once and for all) 1. Calculate thearrow_forwardFor the first two blanks: your answer should include only numbers and a decimal. Do not include the %-sign. Round your answer to 1 decimal place if necessary. If the nominal interest rates is 6.6% and the expected real interest rate is 5.1%, then the expected inflation rate is equal to %. Suppose the actual inflation rate is equal to 1.2%. Then the actual real interest rate is equal to %. Relative to the expected inflation rate, the actual inflation rate is good for the but bad for the For both blanks, choose from: borrower, lender It is important that you type in your answers exactly as it appears in the options provided. Quercus is case-sensitive.arrow_forward
- Now, consider an economy in which the demand for money is of the formY / (1 + it) for t = 0, 1, 2, · · · , where output is 150 and it denotes the nominal interest rate inperiod t. The real interest rate, denoted r, is constant and equal to 4%. In period0 and 1, the money supply is 100 and people expect that money supply wouldbe 100 forever. People have rational expectations. In period 2, the central banksurprises people and sets the money supply will grow at 2 percent forever, that is,M0 = 100, M1 = 100, M2 = (1.02)M1, M3 = (1.02)M2, and so on. A . Find the inflation rate, nominal interest rate, real money balance in period 1,and expected inflation in period 2, given the information available in period1, π1, i1, M1 / P1 and, E1π2. B . Find the inflation rate, nominal interest rate, real money balance in period 2, and expected inflation in period 3, given the information available in period 2, π2, i2, M2 / P2 and E2π3. C . Compare E1π2 and π2.arrow_forwardAsaparrow_forward23. For this question, assume that expectations of P and A are correct. Based on price setting behavior, the real wage will be equal to which of the following? A) A/(1+m) B) AP/(1+m) C) APF(u, z) D) P(1+m) E) none of the abovearrow_forward
- a) The 1-year bond yield is currently at 0.5% and the 2-year bond yield is 1%. Inflation is expected to be 2% for the next year. i. What is the 1-year bond yield expected in one year time? ii. What is the current 1-year real interest rate? b) Consider that the central bank is deciding to raise interest rates. With the aid of an expectations modified IS-LM diagram, clearly show the impact on current output if (i) the interest rate rise is limited to 1 year and (ii) if the interest rate rise is expected to be in place for several years.arrow_forwardIn a particular economy the real money demand function is Real Interest Rate, r (%) 0.451 M 0.40- 3,000 + 0.10Y-9,000i. P 0.35- Assume that M = 7,000 and P = 2. Initially, expected inflation, zewas 0.02. Initially, when Y= 8000, the real interest rate of 0.013 cleared the asset market and when Y = 9000, the real interest rate of 0.024 cleared the asset market. The initial LM curve is drawn as 0.30- 0.25 0.20- LM,. 0.15- Now suppose that the expected inflation rate increases to 0.03. Using the new expected inflation rate, calculate the real interest rate that clears the asset market when Y = 8000. (Enter your answer in decimals, rounded to three decimals.) D. This is point C. 0.10- LM, 0.05- 0.00+ 7 8 10 Output, Y (thousands)arrow_forwardUnder the Pure Expectations Theory, if these investors believe that interest rates will rise in the near future, a. Two statements are correct. b. they will make up for the lower short-term yield when the short-term securities mature, and they reinvest at a higher rate (if interest rates rise) at maturity. c. All statements are correct. d. the large supply of funds in the short-term market will force annualized yields down, while the reduced supply of long-term funds forces long-term yields up. e. they will invest their funds mostly in the short-term risk-free securities so that they can soon reinvest their funds in securities that offer higher yields after interest rates increase. f. their actions cause funds to flow into the short-term market and away from the long-term market. g. Three statements are correct.arrow_forward
- Suppose the money demand function is = 1000 + 0.2Y - 1000 (r + πe). Required (a.) Calculate velocity if Y = 2000, r = 0.06, and πe = 0.04. (b.) If the money supply (Ms) is 2600, what is the price level? (c.) Now suppose the real interest rate rises to 0.11, but Y and Ms are unchanged. What happens to velocity and the price level? (d.) For part (c.), if the nominal interest rate were to rise from 0.10 to 0.15 over the course of a year, with Y remaining at 2000, what would the inflation rate be?arrow_forwardSoved 6. 00:54:01 01234 5 67 89 Unemployment rate (%) Refer to the above diagram for a specific economy. The shape of this curve suggests that Rate of inflation (%) 7956 321arrow_forwardEconomics A recent edition of The Wall Street Journal reported interest rates of 6 percent, 6.35 percent, 6.65 percent, and 6.75 percent for three- year, four- year, five- year, and six-year Treasury notes, respectively. According to the unbiased expectations theory, what are the expected one- year rates for years 4, 5, and 6 (i. e., what are 4f1, 5f1, and 6f1)?arrow_forward
Economics (MindTap Course List)EconomicsISBN:9781337617383Author:Roger A. ArnoldPublisher:Cengage Learning