Economics 470/570 - Monetary Theory and Policy

Homework 8

Economics 470/570
Winter 2005
Review Question Set for Week #8

Definitions

Liquidity trap

Monetary shock

SRAS

Full employment

Wealth effect

Real shock

LRAS

Inflationary and recessionary gaps

Short Answer

1. Use the IS-LM model to show that velocity is constant in the classical version of the model, but not in the Keynesian version.

2. Use the IS-LM model to show and explain how price adjustments return the economy to full employment when output differs from its full employment level.

3. Use the IS-LM model to derive the AD curve. Explain intuitively why the AD curve slopes downward.

4. Use IS-LM and AD diagrams to show how the AD curve shifts when there is a shift in either the IS or LM curve due to any factor except changes in price and income.

5. Use the IS-LM model to show that the model is classical in the LR, i.e. that (a) output does not change in the LR, (b) monetary shocks do not affect the real interest rate in the LR, (b) real shocks do affect the real interest rate in the LR.

6. Explain why the SRAS curve (assuming fixed wages in the SR) slopes upward. Explain why the curve shifts when the fixed wage is reset.

7. Use the fixed wage AD-AS model to show the SR and LR adjustment to AD shocks.

Essay

1. Explain and show graphically using the IS-LM model that wage stickiness can impede the economy’s return to full employment.

2. What is a liquidity trap and how does it arise? Explain your answer intuitively and graphically. Is the economy more likely to be in a liquidity trap near full employment or in a recession? Explain.

3. Explain and show graphically using the IS-LM model how the economy can become stuck in a liquidity trap with output less than its full employment level. How can wealth effects overcome this problem?

4. Explain and show graphically using the IS-LM model that when investment is highly insensitive to changes in interest rates, the automatic adjustment mechanism that returns the economy to full employment can break down.

5. In the classical version of the IS-LM model, show that (a) fiscal policy is ineffective, and (b) monetary policy is fully effective. In what sense is the result for monetary policy inconsistent with the classical view?

6. In the Keynesian liquidity trap version of the IS-LM model, show that, when the economy is in the liquidity trap, (a) monetary policy is ineffective, and (b) fiscal policy is fully effective. Show that the results (a) and (b) also hold in the Keynesian vertical IS version of IS-LM model.

7. Is the private sector inherently stable, i.e. does the economy self correct quickly when there are inflationary or recessionary gaps? Discuss using graphs where appropriate. Is there a role for stabilization policy?

Homework 7

Economics 470/570
Winter 2005
Review Question Set for Week #7

Definitions

IS curve

LM curve

Policy effectiveness

Crowding out

Short Answer

1. Derive the LM curve graphically and explain intuitively why the LM curve slopes upward.

2. Explain why the LM curve is vertical when money demand is unaffected by changes in the interest rate (as in the classical model). More generally, explain why the LM curve is steeper when money demand is less sensitive to the interest rate.

3. Derive the IS curve graphically and explain intuitively why the IS curve slopes downward.

4. Explain why the IS curve is steeper when the sensitivity of investment to the interest rate falls.

5. When is investment more sensitive to changes in the interest rate, at full employment or in a recession? Explain.

6. When is money demand more sensitive to changes in the interest rate, at full employment or in a recession? Explain.

7. Is there any difference between using a tax cut to stimulate output rather than increasing government spending? Explain.

Essay

1. What factors cause the LM curve to shift? In what direction do they shift the LM curve? Show the shifts graphically using money demand - money supply and LM curve diagrams.

2. Show graphically and explain intuitively how the slope of the LM curve changes when the responsiveness of money demand to the interest rate (|L_R|) increases.

3. What factors cause the IS curve to shift? In what direction do they shift the IS curve? Show the shifts graphically using 45 degree line and IS curve diagrams.

4. Show graphically and explain intuitively how the slope of the IS curve changes when the responsiveness of investment to the interest rate (|IR|) increases.

5. Consider points above or below the LM curve. Explain why there is excess demand or excess supply at each point and the forces that cause i to change so as to restore equilibrium. Next, consider points above or below the IS curve. Explain why there is excess demand or excess supply at each point and the forces that cause y to change so as to restore equilibrium. Use these results to explain why the IS-LM model is stable.

6. Show graphically and explain intuitively how an increase in (a) the money supply, and (b) government spending affects income and the interest rate in the IS-LM model.

7. Use the IS-LM model to examine how the relative effectiveness of monetary and fiscal policy changes as investment becomes less sensitive to the interest rate. Explain the result intuitively.

8. Use the IS-LM model to examine how the relative effectiveness of monetary and fiscal policy changes as money demand becomes less sensitive to the interest rate. Explain the result intuitively.

Homework 6

Economics 470/570
Winter 2005
Review Question Set for Week #6

Definitions

Consumption, disposable income, MPC and MPS

Investment

Government spending

Aggregate demand or expenditures

Autonomous expenditures

Expenditure multiplier

Transactions, precautionary, and speculative demand for money

Liquidity preference

Autonomous money demand

Short Answer

1. Explain why investment is negatively related to the interest rate.

2. Explain why setting income equal to expenditures is equivalent to setting saving equal to investment.

3. What is the expenditure multiplier? Why is it useful?

4. Show the money demand curve graphically. Show how the money demand curve shifts when income increases.

Essay

1. What does the 45 degree line diagram show? Show the equilibrium on the 45 degree line diagram and explain how the economy moves to equilibrium if output differs from its equilibrium value. How will the equilibrium level of output change if there is a change in autonomous consumption, investment, government spending, or taxes? Explain. How will income change if the interest rate falls?

2. Discuss the transactions, precautionary, and speculative motives for holding money in Keynes liquidity preference theory. When all three motives are put together, what theory of money demand emerges?

3. Explain intuitively and use a money demand – money supply diagram to show how the interest rate changes if (a) the nominal money supply increases, (b) the price level increases, (c) real income increases, and (d) an increase in autonomous money demand.

4. According to Baumol, the transactions demand for money depends upon the interest rate as well as nominal income. Explain why the transactions demand for money depends upon the interest rate. Why is this important?

Homework 2 Update

Economics 470/570
Winter 2005
Review Question Set for Week #2

[ADDS PAGE NUMBERS FROM MISHKIN’S TEXT]

Definitions

FOMC [341]

FAC [345]

Discount window [359]

Discount rate [359]

Member bank [340]

Federal Funds rate [393]

Short Answer

1. What are the three types of financial intermediaries? What types of firms are in each category? [34-37]

2. Briefly describe the major functions of Federal Reserve district banks. [339]

3. Who is on the FOMC? What does the FOMC do? [341-344]

Essay

1. What are the reasons for regulating financial markets? Discuss the types of regulations that have been imposed on financial markets. [37-40]

2. Describe the structure of Federal Reserve districts and Federal Reserve banks. [336-340]

3. Describe the structure and function of the Board of Governors of the Federal Reserve System. [340-341]

4. How has the power structure of the Federal Reserve System shifted over time? [344-346]

5. How independent is the Fed? What factors contribute to independence? What factors work against independence? Discuss arguments for and against the independence of the Fed (we will discuss this part of the question next class). [346-349, 352-354]

 

Homework 1 Update

Economics 470/570
Winter 2005
Review Question Set for Week #1

[ADDS PAGE NUMBERS FROM MISHKIN'S TEXT]

Definitions

Medium of exchange/Double coincidence of wants [45-47]

Unit of account/Multiplicity of prices [45-47]

Store of value/Liquidity [45-47]

Financial intermediary [29]

Direct and indirect finance [23-25]

Liquidity [47]

Short Answer

1. How is money measured? Why is there more than one definition of the money supply? [51-55]

2. How do bonds and equities differ? Which is more risky? [25-26]

3. How do bond and equity markets differ? How do primary and secondary markets differ? How do money and capital markets differ? [25-28]

4. Explain how secondary markets determine the price of new securities and why they make new securities easier to sell. How do over-the-counter markets and organized exchanges differ? [26-27]

5. List and briefly describe the various money market instruments.

http://wps.aw.com/wps/media/objects/744/761962/appendixes/ch02appendix.pdf

6. List and briefly describe the various capital market instruments.

http://wps.aw.com/wps/media/objects/744/761962/appendixes/ch02appendix.pdf

Essay

1. Why study of money? Why study banking? Why study financial markets? [3-13]

2. What are the functions of money, i.e. why does money exist? Relative to a barter economy, what problems are overcome by the use of money? [45-48]

3. Describe the main function of financial markets. Explain how direct finance and indirect finance differ. Among households, government, business, and the foreign sector, who are the biggest borrowers/lenders? [29-32 plus class notes]

4. How do financial intermediaries, through their ability to pool resources promote more efficient use of financial resources? Be sure to cover risk pooling, the pooling of small investors, and pooling over time in your answer.

5. How do financial intermediaries reduce default risk, transactions costs, and matching costs? [29-32 plus class notes for both 4 and 5]

Homework 5

Economics 470/570
Winter 2005
Review Question Set for Week #5

Definitions

Monetary aggregate

Velocity of money

Output gap

Short Answer

1. Show that if the Fed controls either the federal funds rate or bank reserves, then the variance of the other variable increases.

2. Can the Fed control bank reserves exactly? Explain. Why is this important?

3. What is the Taylor rule? How is it used? How well does it predict Fed policy?

4. What is meant be the phrase “money is a veil” in the classical model? What is the role of money in the classical model?

5. What is the difference between real and nominal money? Do changes in nominal money also change real money in the classical model? Explain.

6. What is the difference between real and nominal interest rates? How do the ex-ante and ex-post real interest rates differ?

7. Represent the classical model using an AD-AS diagram and show that changes in money, government spending, and taxes do not affect real output. What is the AD curve in the classical model?

Essay

1. Explain the reasons for the Fed’s decision to adopt an interest rate target rather than a monetary aggregate target.

2. State Say’s law. What is the significance of this in terms of government stabilization policy? Explain why Malthus does not believe in Say’s law. How does classical interest theory answer address Malthus’ criticism of Say’s law?

3. Explain classical interest theory. Be sure to explain why the investment function slopes downward and the saving function slopes upward.

4. Explain the quantity theory of money. Explain the Cambridge approach and illustrate that it leads to the same identity as the quantity theory. What assumptions are imposed to arrive at a theoretical statement?

5. What is the money demand function in the classical model? What factors determine velocity? How do these factors affect money demand?