Suppose the central bank subscribes to a monetarist approach to monetary policy. The central bank believes that the velocity of money grows at a predictable rate of 2% per year and that potential real GDP grows at 4% per year. If the central bank observes a monetary policy rule that stipulates money supply growth of 5% per year, it will expect an inflation rate of 11% Y per year and nominal GDP growth of 7% Y per year.
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- There are two countries in the world, A and B. Suppose the central bank in country A has an annual inflation target pai = 0.02 while the central bank in country B has anannual inflation target pai = 0.03. In the long run, we would expect the nominalexchange rate of country A to appreciate against country B at a rate of about 1% per year.True or False? Explain.b. Suppose a country has a money demand function (M/P)d= kỲ, where k is a constant parameter. The money supply grows by 12 percent per year, and real income grows by 4 percent per year. What is the average inflation rate?Suppose the Central Bank sets 1 year real interest rates by following this Taylor rule: rt = r +0.5(π⁹² − л*) and where r = 4% and л* = 3% - where is the expected inflation rate Nominal interest rates are equal to the real interest rate plus the expected inflation rate it = rt + πe (a) Suppose in period 1 inflation is expected to be 1%. Calculate the 1 year nominal and real interest rates in period t. (b) Calculate the 1 year nominal and real interest rates when inflation is expected to be 5% for the period t+1. (c) (d) (e) Calculate the 1 year nominal and real interest rates when inflation is expected to be 5% for the period t+2. Calculate the nominal 2 year rate and 3 year rates at time t, for the yield curve. What will the yield curve look like and why?
- According to the Fischer equation, if the nominal interest rate is 8% and inflation is running at 4% then the real interest rate is? 12% 8% 4% 2%The money supply of a country has been growing for many years causing expected inflation of 8% per year. The economy’s current GDP growth rate is 1%. The Central Bank’s full employment target GDP growth rate is 5%. The “real” interest rate, r, is 4%. Following a policy that targets only inflation, with speed of adjustments ay =0 and aπ = 0.5, where 6% is the new target inflation rate what should their target nominal interest rate be set at?Which of the following will result in an increased inflation rate? Select One: a) Low interest rates, low government spending b) High interest rate, low taxes c) Low interest rate, high taxes d) High interest rate, high government spending e) Low interest rates, low taxes
- If the money supply (M) is $300, the real GDP (Q) is 200, the velocity of money (V) is 6, the interest rates is 5% and the inflation rate is 3%, then calculate nominal GDP.Suppose that an economy has a constant nominal money supply, a constant level of real output Y = 1500, and a constant real interest rate r = 0.05, and it’s expected rate of inflation is 2%, i.e, πe = .02. Suppose that the income elasticity of money demand is ηY = 0.5 and the interest elasticity of demand ηi = –0.2. (a) Suppose that Y decreases to 1425, r remains constant at 0.05 and there is no change in the expected rate of inflation. What is the percentage change in the equilibrium price level? (b) Suppose that r increases to 0.06 and Y remains at 1500. Assuming that expected inflation remains at πe = .02, what is the percentage change in the equilibrium price level? (c) Suppose that r increases to 0.06. Assuming that πe = .02, what would real output have to be for the equilibrium price level to remain at its initial value?In an economy at its steady state, real GDP, Y, increases at the rate g+n, where g is the technological growth rate and n is the rate of population growth. The monetary base M is equal to nominal GDP divided by the velocity of money V i.e. M = PY/V where P is the price level. Thus, assuming the velocity of money is constant, the growth rate of the monetary base will be (approximately) ΔΜ = +g+n M where is the inflation rate. The velocity of money is determined by the function V = V°ebi The nominal interest rate i is determined by i = r" +7, where the natural real interest rate r" is constant in steady state and taken as given. Assume that n = 0, g = 0.03, r" = 0.05, b =1, and Vo = 20. (a) What is the seignorage as a fraction of nominal GDP, when inflation is T = 0.01? (b) What is the seignorage as a fraction of nominal GDP, when inflation is a = 0.10? (c) What rate of inflation maximizes seignorage? (d) What is the maximal seignorage as a fraction of nominal GDP?
- In an economy at its steady state, real GDP, Y, increases at the rate g+n, where g is the technological growth rate and n is the rate of population growth. The monetary base M is equal to nominal GDP divided by the velocity of i.e. M - PY/V where P is the price level. Thus, assuming the velocity of money is constant, the growth rate of the monetary base will be (approximately) money V ΔΜ =*+g+n M where is the inflation rate. The velocity of money is determined by the function V = V°ehi The nominal interest rate i is determined by i = r" +T, where the natural real interest rate r" is constant in steady state and taken as given. Assume that n = 0, g= 0.03, r" = 0.05, 6 =1, and V" = 20. (a) What is the seignorage as a fraction of nominal GDP, when inflation is a = 0.01? (b) What is the seignorage as a fraction of nominal GDP, when inflation is a =0.10? (c) What rate of inflation w maximizes seignorage? (d) What is the maximal seignorage as a fraction of nominal GDP?Antonio receives a portion of his income from his holdings of interest-bearing U.S. government bonds. The bonds offer a real interest rate of 4.5% per year. The nominal interest rate on the bonds adjusts automatically to account for the inflation rate. The government taxes nominal interest income at a rate of 10%. The following table shows two scenarios: a low-inflation scenario and a high-inflation scenario. Given the real interest rate of 4.5% per year, find the nominal interest rate on Antonio's bonds, the after-tax nominal interest rate, and the after-tax real interest rate under each inflation scenario. Inflation Rate (Percent) After-Tax Nominal Interest Rate (Percent) Real Interest Rate Nominal Interest Rate After-Tax Real Interest Rate (Percent) (Percent) (Percent) 2.0 4.5 4.5 9.5 Compared with lower inflation rates, a higher inflation rate will quantity of investment in the economy and the after-tax real interest rate when the government taxes nominal interest income. This…Suppose that the real money demand function is L(Y,r+πe)=0.3Y÷ (r+πe) Where Y is real output, r is the real interest rate, and πe is the expected rate of inflation. Real output is constant over time at Y = 1500. The real interest rate is fixed in the goods market at r = 0.5 per year. Suppose that the nominal money supply is growing at the rate of 10% per year and that this growth rate is expected to persist for ever. Currently, the nominal money supply is M = 400. What are the values of the real money supply and the current price level? (Hint: What is the value of the expected inflation rate that enters the money demand function?). Suppose that the nominal money supply is M = 400. The Bank of Namibia announces that from now on the nominal money supply will grow at the rate of 5% per year. If everyone believes this announcement, and if all markets are in equilibrium, what are the values of real money supply and the current price level? Explain the effects on the…