Eco HW

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Economics 350 Student Name:

Spring 2014 ID #:

Homework #5

Due: Thursday, May 8 in class

Total Points Available: 40

Question 1. (2 points) Suppose that velocity is constant at 9, but the nominal money

supply increases from $1.5 to $1.8 trillion. What must happen to nominal output?

Suppose further that real output is constant at 13.5 trillion “units”: what must happen

to the price level?

Question 2. (2 point) The picture below, sourced from the Federal Reserve Bank of St.

Louis, shows M1 velocity for 1959-2014. Why has velocity fallen since 2008?

Question 3. Answer the following questions from Chapter 23 of the Mishkin textbook.

a. (2 points) (based on Mishkin 23.3) What happened to the position of the short-run aggregate supply curve due to the depreciation of dollar from December 2008 to

December 2009(as foreign goods become expensive in the U.S)? What happened to

the (Keynesian) aggregate demand curve?

b. (2 points) Suppose that consumer spending decreases and at the same time Fed increases money supply. What will happen to the (Keynesian) Aggregate Demand

curve?

Question 4. Once the crowding-out effect is accounted for, how will the following events

affect the aggregate demand curve, as well as real interest rates? Use a Keynesian

perspective. Use graphs for your answer.

a. (2 points) The open market desk in the New York Fed conducts open market purchase.

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b. (2 points) Federal government increases income tax.

Question 5. Suppose that investors become more optimistic about the housing market

and purchases of new homes increase. Using the AD-AS model (with a Keynesian

perspective), answer the following questions.

a. (4 points) In the absence of any policy intervention, what will happen to prices and output over the short-run and long-run? What will happen to real interest rates in the

long-run?

b. (4 points) Taking an activist (Keynesian) approach, show how one can use fiscal policy to return the economy to full employment. Would taxes be increased or

decreased? How about government spending? If these policies were implemented,

what would happen to interest rates?

c. (6 points) Repeat part (b) for monetary policy. Would the Federal Reserve make an open market purchase or sale? What would happen to interest rates in this case?

Question 6. The Federal reserve started paying interest on excess reserves in 2008.

a. (2 points) How would this affect the nominal money supply?

b. (4 points) Using the AD-AS model, show graphically how the change in the money supply described in part (a) would affect prices and output over the short- and long-

run. What would happen to real interest rates in the long-run?

Question 7. In the December 7, 2010 edition of The New York Times, David Leonhardt

discussed the tax and spending deal President Obama reached with Congressional

Republicans:

Mr. Obama effectively traded tax cuts for the affluent, which Republicans

were demanding, for a second stimulus bill that seemed improbable a few

weeks ago. Mr. Obama yielded to Republicans on extending the high-end

Bush tax cuts and on cutting the estate tax below its scheduled level. In

exchange, Republicans agreed to extend unemployment benefits, cut

payroll taxes and business taxes, and extend a grab bag of tax credits for

college tuition and other items. … [W]ith the recovery faltering and

Republicans retaking the House, the administration is turning back to

short-term job creation.

Use the (Keynesian interpretation of the) AD-AS model to answer the following

questions. You can assume the decline in wealth reflects speculative forces.

a. (4 points.) Many observers attribute the recession/faltering recovery to a decrease in

consumer and business spending, in turn driven by decreases in wealth and optimism.

Using graphs, show how, in the absence of any stabilization policies, these spending

decreases would affect prices and output in the short and long run. In addition, show

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how real interest rates change in the long run. Assume that immediately before the

spending decreases occur, the economy is at full-employment output.

b. (4 points.) Using graphs, show how the deal reached by President Obama would

offset the effects of the spending decrease described in your answer to part (a). If

these policies are implemented, what would happen to real interest rates?