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**Economics 251 Problem Set 4 Spring 2021**

ORDER # | 100038 |

PAPER TYPE | MATH PROBLEMS |

WRITING LEVEL | UNDERGRADUATE |

WRITING STYLE | APA |

# OF SOURCES | N/A |

# OF QUESTIONS | 8 |

**Your Name (please print clearly) _____________________________**

**Economics 251: Spring 2021 **

**Professor:**

**Intermediate Macroeconomics**

**Economics 251 Problem Set 4 Spring 2021 Problem Set 4, Part 1**

**Due: Friday April 16, 11PM csteven4@oberlin.edu & jduca@oberlin.edu**

**Economics 251 Problem Set 4 Spring 2021 Assignments to be handwritten then scanned into a single pdf (except for approved**

**disabilities), which is to be sent to csteven4@oberlin.edu & jduca@oberlin.edu with a subject**

**line of E251 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: E251_PS4P1_yourlastname_yourfirstname.**

**For example, if your name were Janine Smith, your pdf file should be named:**

**E251_PS4P1_Smith_Janine.**

**1) Calculating Inflation in the Monetarist Model (4 points in total) Write down**

**the growth rate version of the modern quantity theory of money (1 point). According to**

**the basic assumptions of monetarism, what would most likely be the average annual**

**inflation rate if money growth equaled 23 percent, and trend real GDP growth equaled 9**

**percent (1 point)? Show your formulas and calculations. (1 point) Briefly discuss in one to**

**two sentences the main reason why most major central banks do not target money supply**

**growth (1 point).**

**2) Shifting the IS and MP Curves (21 Points in Total)**

**2A) Fiscal Policy (11 points). Assume that the monetary policy rule is unchanged in**

**problem (2A). Assume that the mpc is 0.80. If government spending is reduced by**

**$500 billion, what happens to the IS curve? Draw an initial IS curve and an MP curve**

**in a diagram with the real interest rate (r) on the y axis and real output (y) on the xaxis. Calculate by how much and in which direction the IS curve shifts horizontally (2**

**points). Draw the IS curve after the change in policy and indicate the new intersection**

**of the IS and the MP curves after the change in policy (2 points). Label the initial and**

**final curves, the initial and final equilibrium points, and label the initial and final**

**values of r and y on each axis. What can you say about the magnitude of the change**

**in output from the initial to the final level of output (1 pts.) and why (2 pts.)?**

**According to the gov’t spending multiplier = (1/(1-mpc)) = 1/(1-.80) = 1/.2 = 5,**

**In a separate diagram—this one with inflation on the y-axis and real output on the xaxis, depict the initial ISMP curve. Draw in the ISMP curve after the fiscal policy action**

**in problem 2A. (2 points) What can you say about the magnitude of the horizontal**

**shift of the ISMP curve compared to the horizontal shift of the IS curve (2 points)? **

**2B) Monetary Policy (5 points). Assume that fiscal policy is unchanged in problem (2B)**

**Draw an initial IS curve and an MP curve in a diagram with the real interest rate (r) on**

**the y axis and real output (y) on the x-axis. Draw a new MP curve assuming that the**

**central bank adopts a more stimulative/expansionary monetary policy rule and**

**indicate the new intersection of the IS and the MP curves after the change in policy (2**

**points). Label the initial and final curves, the initial and final equilibrium points, and**

**label the initial and final values of r and y on each axis.**

**In a separate diagram—this one with inflation on the y-axis and real output on the xaxis, depict the initial ISMP curve. Draw in the ISMP curve after the monetary policy**

**action in problem 2B. (1 point) What can you say about the magnitude of the**

**horizontal shift of the ISMP curve compared to the horizontal shift of the MP curve**

**(2 point)? **

**2C) An Economic Shock (5 points). Assume that the monetary policy rule and fiscal policy**

**is unchanged in problem (2C). Draw an initial IS curve and an MP curve in a diagram**

**with the real interest rate (r) on the y axis and real output (y) on the x-axis. Which**

**curve shifts and in which direction if there were a sudden rise in consumer and**

**business uncertainty (2 points). Indicate the new intersection of the IS and the MP**

**curves after the change in policy (1 points). Label the initial and final curves, the initial**

**and final equilibrium points, and label the initial and final values of r and y on each**

**axis.**

**In a separate diagram—this one with inflation on the y-axis and real output on the xaxis, depict the initial ISMP curve. Draw in the ISMP curve after the shock to**

**uncertainty in problem 2C. (1 point) What can you say about the magnitude of the**

**horizontal shift of the ISMP curve compared to the horizontal shift of the IS curve (1**

**point)? **

**3. (35 points) The Phillips Curve in Country A takes the form 𝝅 = 𝟑 − 𝟎. 𝟕𝟓(𝒖 − 𝟒) ,**

**where 𝝅 is the actual inflation rate (as opposed to the expected inflation rate) and 𝒖 is**

**the unemployment rate. The Phillips Curve in Country B takes the form 𝝅 = 𝟒 −**

**𝟎. 𝟓𝟎(𝒖 − 𝟔). The current unemployment rate in both countries is 4%.**

**a. (12 points) Calculate each of the following features of the Phillips Curve trade-off for**

**the two countries. (2 points for each correct answer)**

**Natural rate of unemployment: Country A %; Country B %**

**Expected rate of inflation: Country A %; Country B %**

**Actual rate of inflation: Country A %; Country B %**

**b. (8 points) Suppose policymakers implement policies that reduce the unemployment**

**rate to 2% in the short run. (You will redo problem (3a) except the current**

**unemployment rate in both countries is 2%.) Determine the impact on inflation in each**

**of the two countries (unchanged, up X percentage points, down X percentage points),**

**and explain any differences you see. (3 points for each correct change in inflation, 1**

**point for the explanation)**

**Change in inflation in Country A: percentage points.**

**Change in inflation in Country B: percentage points.**

**Explanation:**

**c. (15 points) Now assume price expectations are formed adaptively (𝑬𝝅 = 𝝅−𝟏) and that**

**both countries have been at their respective natural rates of unemployment long enough**

**that inflation is at the expected rate shown for each country in part a. Start from each**

**country having its unemployment rate at its natural rate in year 2021. If policymakers**

**implement policies aimed at keeping the unemployment rate at 2 percent that takes**

**effect starting in 2022, show what will happen in each country to the inflation rate over**

**the next five years.**

**Assume that u<un lowers inflation in the year it occurs for the expected inflation rate it**

**inherited from the prior year. Under the conditions, for 2021, Eπ = π in each country**

**10 points for the table, ½ point for each entry 2022 to 2025 and 2 for getting the entire**

**table correct.**

**Country A Country B**

**Year 𝑬𝝅 𝝅 𝑬𝝅 𝝅**

**2021 3.00% 3.00% 4.00% 4.00%**

**2022 % % % %**

**2023 % % % %**

**2024 % % % %**

**2025 % % % %**

**In which of the two countries do you think adaptive inflation expectations adaptively**

**would break down soonest? (2 points) Why? (2 points)**

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