Question

Here are 3 monetary policy rules. Assume that PPP, Quantity Theory, and the Fisher effect are correct.

a. The Swiss National Bank (central bank) targets money supply growth and sets it at 8% per year. The growth rate of real Swiss GDP is 3%. What is Switzerland’s inflation rate? What money supply growth rate would result in 2% inflation?

b. The Reserve Bank of New Zealand targets the nominal interest rate. Its target is 6%. The real interest rate is 1.5%. What is New Zealand’s inflation rate? What nominal interest rate target would result in inflation of 2.5%?

c. Lithuania’s central bank targets the exchange rate. It keeps the lita within ± 15% of its target exchange rate of 3.4528 litas per €.

1) What are the upper and lower limits of this exchange rate band?

2) Assume euro inflation is 2% per year and Lithuanian inflation is 5%. By what percent will the lita depreciate against the euro?

3) For how long can the lita stay within the band?

4) Is a fixed exchange rate within a band enough to have Lithuanian inflation converge to Eurozone inflation?

Answer #1

The quantity theory of money we discussed in class assumes that
the ratio of money to GDP is constant. This can be equivalently
expressed by the Fisher equation:
M ×V = P × Q
Where:
• M represents the money supply.
• V represents the velocity of money. which is the
frequency at which the average same unit of currency is used to
purchase newly domestically-produced goods and services within a
given time period. In other words, it is the...

Suppose that the real money demand function is
L(Y, r+πe)=0.01Yr+πe ,L(Y, r+πe)=0.01Yr+πe ,
where YY is real output, rr is the real interest rate, and πeπe
is the expected rate of inflation. Real output is constant over
time at Y=150Y=150. The real interest rate is fixed in the goods
market at r=0.05r=0.05 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
forever. Currently,...

Suppose that the money demand function takes the form
(M/P)d = L (i, Y) = Y/(5i)
a. If output grows at rate g and the nominal interest rate is
constant, at what rate will the demand for real balances grow?
b. What is the velocity of money in this economy?
c. If inflation and nominal interest rates are constant, at what
rate, if any, will velocity grow?
d. How will a permanent (once-and-for-all) increase in the level
of interest rates...

1. Use the quantity theory of money equation to address the
following questions. Use the following as initial values: M = $4
trillion, V = 3, P = 1, Y = $12 trillion. (2 points) MV = PY a. All
other things being equal, by how much will nominal GDP expand if
the central bank increases the money supply to $4.2 trillion and
velocity remains constant? Show your work and explain your answer.
b. Reset your values to the initial...

The main advantage of using the interest rate, rather than the
money supply, as the policy instrument in the dynamic
AD–AS model is that it is more realistic. Today, most
central banks, including the Federal Reserve, set a short-term
target for the nominal interest rate. Keep in mind, though, that
hitting that target requires adjustments in the money supply. For
this model, we do not need to specify the equilibrium condition for
the money market, but we should remember that...

The main advantage of using the interest rate, rather than the
money supply, as the policy instrument in the dynamic
AD–AS model is that it is more realistic. Today, most
central banks, including the Federal Reserve, set a short-term
target for the nominal interest rate. Keep in mind, though, that
hitting that target requires adjustments in the money supply. For
this model, we do not need to specify the equilibrium condition for
the money market, but we should remember that...

Over the last 10 years, the dollar has depreciated sharply
vis-à-vis the euro. Suppose that in the short run the Fed wanted
both to defend the dollar (that is, stop its decline and/or cause
it to appreciate) and stimulate investment.
Can it achieve both of these goals simultaneously through
monetary policy?
A.
Yes, to stimulate investment the Fed will use expansionary
policy that will raise interest rates. The higher interest rates
will reduce investment into the United States, which will...

Question 1 (1 point)
Which of the following can cause relative PPP to NOT hold in
the short run?
Question 1 options:
frictionless markets
state-sponsored monopolies
types of labor and unique skill sets than can only be found in
one area or certain areas
shipping costs
Question 2 (1 point)
If relative PPP holds, absolute PPP must hold.
Question 2 options:
True
False
Question 3 (1 point)
In 2019, the US had the highest nominal GDP in the world,
before...

The income elasticity of money demand is 0.5 and the interest
rate elasticity of money demand is -0.2. Real income is expected to
grow by 4% over the next year and the real interest rate is
expected to remain constant over the next year. The rate of
inflation has been zero for several years. If the central bank
wants zero inflation over the next year, it should choose _______%
for the growth rate of the nominal money supply.

Assume the real money demand function is
L(Y;i)=2000+0.3Y-5000i
where Y is real output, P is the price level, i is the nominal
interest rate on non-monetary assets and monetary assets earn no
interest.
a) Assuming that the asset market is in equilibrium at i=0.05.
Find equilibrium levels of real money supply, nominal money supply,
and the velocity of money if P=100, and
Y=2000.
b) Find the real income elasticity of money demand at the
equilibrium level of money balances found...

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