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money market equilibrium

money market equilibrium

ENGR.ECONOMIC ANALYSIS
ENGR.ECONOMIC ANALYSIS
14th Edition
ISBN:9780190931919
Author:NEWNAN
Publisher:NEWNAN
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
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C = 100 + 0.5 · (Y – T) I = 500 – 1000 -r where Y is real output and r is the real interest rate. Government purchases and taxes are Ğ = 500, Ť= 100. The LM (money market equilibrium) curve is Y 5i where P is the price level and i is the nominal interest rate. The Central Bank (CB) is initially supplying M = 8000 units of money, and expected inflation is a = 0. Assume that the long-run equilibrium level of output is Y = 2000. Short-run equilibrium output is initially at the same level (Y = 2000). Suddenly, news of a new world-beating super-vaccine raises expected inflation to = 0.05. 1. Suppose the government (not the CB) wants to stabilise the shock in the short-run. Explain whether it should inerease the government deficit (AĞ > AT) or reduce it (AĞ < AŤ), and how it works. 2. Now suppose the government doesn't do anything, and the CB wants to stabilise the shock in the short-run. Explain whether it should decrease or increase money supply M if it wants to bring output Y back to its long-run equilibrium level. What would happen to the nominal and real interest rate in the short-run, if the CB follows this policy? 3. Continue to suppose the government doesn't do anything, and the CB wants to stabilise the shock in the short-run but instead of output, the CB wants to bring the nominal interest rate i back to its long-run equilibrium level. Explain whether it should decrease or increase money supply M, and what happens to short-run output Y and the real interest rate r if this policy is followed. 4. Suppose the CB reduces money supply M. Explain how the economy would shift from its short-run to long-run equilibrium. In particular, what happens to output Y, the real interest rate r, and prices P during this process?
Transcribed Image Text:C = 100 + 0.5 · (Y – T) I = 500 – 1000 -r where Y is real output and r is the real interest rate. Government purchases and taxes are Ğ = 500, Ť= 100. The LM (money market equilibrium) curve is Y 5i where P is the price level and i is the nominal interest rate. The Central Bank (CB) is initially supplying M = 8000 units of money, and expected inflation is a = 0. Assume that the long-run equilibrium level of output is Y = 2000. Short-run equilibrium output is initially at the same level (Y = 2000). Suddenly, news of a new world-beating super-vaccine raises expected inflation to = 0.05. 1. Suppose the government (not the CB) wants to stabilise the shock in the short-run. Explain whether it should inerease the government deficit (AĞ > AT) or reduce it (AĞ < AŤ), and how it works. 2. Now suppose the government doesn't do anything, and the CB wants to stabilise the shock in the short-run. Explain whether it should decrease or increase money supply M if it wants to bring output Y back to its long-run equilibrium level. What would happen to the nominal and real interest rate in the short-run, if the CB follows this policy? 3. Continue to suppose the government doesn't do anything, and the CB wants to stabilise the shock in the short-run but instead of output, the CB wants to bring the nominal interest rate i back to its long-run equilibrium level. Explain whether it should decrease or increase money supply M, and what happens to short-run output Y and the real interest rate r if this policy is followed. 4. Suppose the CB reduces money supply M. Explain how the economy would shift from its short-run to long-run equilibrium. In particular, what happens to output Y, the real interest rate r, and prices P during this process?
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