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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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(Reliquefication). Consider a Cagan-type economy in which the demand for money is of the form = (1 + i,)¯"Y Pt for t= 0, 1, 2, ..., where M denotes the demand for nominal money balances, P, the price level, the nominal interest rate, Y real output, and 7> 1 is a parameter. Suppose that the Fisher equation it holds and that the real interest rate is constant and equal to r> 0. Suppose further that economic agents have rational expectations. The money growth rate is u > 0 for t <T-1, that is, M. (1+u) M.-1 for t 1, 2, ..., T-1. Before period T, economic agents believe that the money supply will grow at this rate forever. In period T, unexpectedly, the central bank announces that starting in Tit will stop printing money, that is, M = MT-1 for t = T, T+1, T+ 2, ... Note the difference with the case studied in class (lecture 17), in which the central bank stops printing money in T+ 1, not in T. Pt 1. Find the inflation rate n = Pt-1 1 for the periods t< T, t = T, and t> T. Compare tT under the stabilization program studied here and explain why they are or they are not equal to each other. 2. In class, we showed that if n> 1, the central bank can avoid deflation in period Tby increasing the money supply just in period T at a rate ũ > µ. We called this feature of the stabilization program reliquefication. Find ũ in the present environment as a function of u and 7 and compare it to the one obtained in class. Provide intuition.
Transcribed Image Text:(Reliquefication). Consider a Cagan-type economy in which the demand for money is of the form = (1 + i,)¯"Y Pt for t= 0, 1, 2, ..., where M denotes the demand for nominal money balances, P, the price level, the nominal interest rate, Y real output, and 7> 1 is a parameter. Suppose that the Fisher equation it holds and that the real interest rate is constant and equal to r> 0. Suppose further that economic agents have rational expectations. The money growth rate is u > 0 for t <T-1, that is, M. (1+u) M.-1 for t 1, 2, ..., T-1. Before period T, economic agents believe that the money supply will grow at this rate forever. In period T, unexpectedly, the central bank announces that starting in Tit will stop printing money, that is, M = MT-1 for t = T, T+1, T+ 2, ... Note the difference with the case studied in class (lecture 17), in which the central bank stops printing money in T+ 1, not in T. Pt 1. Find the inflation rate n = Pt-1 1 for the periods t< T, t = T, and t> T. Compare tT under the stabilization program studied here and explain why they are or they are not equal to each other. 2. In class, we showed that if n> 1, the central bank can avoid deflation in period Tby increasing the money supply just in period T at a rate ũ > µ. We called this feature of the stabilization program reliquefication. Find ũ in the present environment as a function of u and 7 and compare it to the one obtained in class. Provide intuition.
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