Economics 211 Problem Set Part I

Economics 211 Problem Set Part I

Due 11 PM, Tuesday, Apr. 13, 2021
John Duca
Problem Set 4 Part 1 Assignments to be handwritten then scanned into a single pdf
(except for approved disabilities), which is to be sent to jduca@oberlin.edu with a
subject line of E211 Problem Set 4 Part 1. There is a 10-point penalty for an
incorrectly named file. You are responsible for naming your pdf file as follows:
E211_PS4P1_yourlastname_yourfirstname. For example, if your name were Janine
Smith, your pdf file should be named: E211_PS4P1_Smith_Janine.
From Mishkin Text and Lectures
1. Suppose that the money supply and nominal GDP (PY means PxY) data for the
fictional country of Suburbia are as follows:
2019 2021
M 2500 5000
PY 8000 14000
Calculate the velocity of money in each year. What happened to the velocity of money
between 2019 and 2021 in the example above? Does this example support or hurt the
case for a monetarist oriented policy? Briefly state why. (6 points)

2. Write down the monetary equation of exchange in levels (multiplicative form) and
separately in terms of growth rates (2 points). Suppose that velocity were constant in the
land of Friedmanonia. If money is growing at a rate of 35 percent and real output grows
at 26 percent, what is the rate of inflation (4 points)? Suppose that money now grew at a
28 percent rate and that the rate of real output growth remained at 26 percent. Calculate
what happens to inflation. (4 points)

From The Mishkin Text and Class Handout (Make sure to have the Taylor Rule example)
3. A. Write down the Taylor Rule as listed in Mishkin. Suppose that inflation were 8%,
the Fed’s inflation target were 4%, the equilibrium real federal funds rate were 2%, and
the output gap equaled 2.5%. According to the Taylor Rule, what should the nominal
federal funds rate equal? At this calculated rate, is the Fed’s stance neutral, stimulative
(expansionary or easy), or restrictive (contractionary or tight)? (8 points)
B. Now suppose that instead of an output gap of 2.5 percent, output was 8 percent below
potential GDP and that nothing else differs about the initial economic conditions in 4A.
What is the output gap (positive or negative)? What should the nominal federal funds rate
equal according to the Taylor Rule? At this calculated rate, is the Fed’s stance neutral,
stimulative (expansionary or easy), or restrictive (contractionary or tight)? (7 points)
C. Go back to the conditions in 3A, so the initial output gap is 2.5% and inflation is 8
percent with an inflation target of 4%. Now suppose that due to a pick-up in productivity
growth, potential GDP growth is higher and is 9.5%, but that actual GDP growth was 2%.
After one year, what will be the new output gap (hint calculate the gap between the actual
and potential growth rates (this is negative) and add this negative difference to the initial
positive output gap)? What should the Fed do to the federal funds rate at that point
according to the Taylor Rule assuming that all the other characteristics of the economy
were the same (Inflation is 8%, that the Fed’s inflation target is 4%, and the equilibrium
real federal funds rate is 2%)? (5 points)

Foreign Exchange Question, From Lectures and Mishkin
4. Suppose that the dollar’s exchange rate value were initially in equilibrium. Suppose
that foreign interest rates fell relative to unchanged interest rates in the U.S. while foreign
income and output remained unchanged throughout this question. What happens to the
exchange rate (E)? Does the dollar appreciate, depreciate or remain the same in this
example? What happens to the relative prices of imports in the U.S. compared to
American made goods? What happens to the relative prices of U.S. exports in foreign
countries compared to foreign goods? All else the same (this includes supposing that
foreign GDP were unchanged), does this shift the aggregate demand curve out to the right, in to the left, or not shift the curve at all? Illustrate what happens to the AS and AD
curves in the short and long runs using the model with a standard amount of credibility in
this example. Assume that the home country were initially in equilibrium with output at
its potential level and inflation equal to the central bank’s long-run target. (Draw an ASAD graph and illustrate the implications of what the macroeconomic impact is of the
change in exchange rates that occurs when the foreign interest rate rises—assuming that
foreign output is unchanged).
(10 points)

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