CH. 5-6 macro

According to the quantity theory of money, a 5 percent increase in money growth increases inflation by ___ percent. According to the Fisher equation, a 5 percent increase in the rate of inflation increases the nominal interest rate by ____ percent.

5;5

An economy with constant velocity has real GDP growth of 3 percent, money growth of 7 percent, and a real interest rate of 2 percent. The nominal interest rate is

6

Purchasing Power Parity

A monetary measurement of development that takes into account what money buys in different countries.

How will a permanent (once-and-for-all) increase in the level of interest rates affect the level and growth rate of velocity?

A one-time increase in the nominal interest rate will cause a one-time increase in velocity, but it will not affect the growth rate of velocity.

If real income growth were higher, inflation would be

Lower

According to the quantity equation, the percentage change in P is approximately equal to the percentage change in:

M minus the percentage change in Y plus the percentage change in velocity.

quantity equation

M x V = P x Y, which relates the quantity of money, the velocity of money, and the dollar value of the economy's output of goods and services

Which equation is used to derive the quantity theory of money?

MV=PY

public savings formula

T-G

if an import restriction does not influence domestic investment or saving, it causes a country's currency to

appreciate, resulting in an unchanged trade balance

If an import restriction does not influence domestic investment or saving, it causes the country's currency to __________, resulting in an _____________ trade balance

appreciate, unchanged

if the demand for real money balances depends on the nominal interest rate then higher inflation

arise from the expectation of future money growth

If the demand for money depends on the nominal interest rate, then via the quantity theory and the Fisher equation, the price level depends on:

both the current and expected future money supply.

Hyper inflation tend to occur

central banks finance large government deficits

monetary neutrality

changes in the money supply have no real effects on the economy

other things equal , an increase in government purchases of goods and services pushes the trade balance toward_______ and causes the currency to ______

deficit, appreciate

nominal exchange rate

determined by the real exchange rate and the price levels in the two countries. other things equal a high rate of inflation leads to a depreciating currency.

real exchange rate =

e x (P/P*) e.g. (yen per dollar x $per unit U.S. goods) / yen per unit Japanese goods

the impact of any policy on the trade balance can be determined by

examining its impact on saving and investment. Policies that raise saving or lower investment lead to a trade surplus and policies that lower saving or raise investment lead to a trade deficit.

NX formula

exports - imports

inflation and nominal interest rates are:

highly positively correlated

Fisher equation

i = π + r

the world interest rate determines the country's level of

investment S - I = NX

When a nation runs a trade deficit,

it experiences a capital inflow.

According to the classical theory of money, reducing inflation will not make workers richer because firms will increase product prices _____ each year and give workers _____ raises.

less; smaller

When investment decreases,

net exports increase

Variables expressed in terms of money are called _____ variables.

nominal

Suppose the government increases both taxes (T) and government purchases (G) by equal amounts. Assuming income (Y) is fixed by the factors of production, the change in national saving (ΔS) will be

(MPC - 1) * (change in T)

Purchasing Power Parity (PPP)

- a doctrine that states that goods must sell at the same (currency-adjusted) price in all countries - the nominal exchange rate adjusts to equalize the cost of a basket of goods across countries e x P = P*

In an open economy,

- spending need not equal output - saving need not equal investment

Assumptions about capital flows

1. Domestic and foreign bonds are perfect substitutes 2. Perfect capital mobility, no restrictions on international trade in assets 3. Economy is small, cannot affect world interest rate r*

An economy produces 50 widgets, which sell for $4 each and has a money supply of $100. The velocity of money is

2

Suppose the price of a cup of coffee is $3 in Boston and 6 euros in Berlin. Use this information to properly answer the following question.According to the theory of purchasing power parity, the exchange rate is

2 euros per dollar

suppose the price of a cup of coffee is $3 in boston and 6 euros in Berlin. According to the theory of purchasseing power parity , the exhange rate is

3 euros per dollar

Some economic historians have noted that during the period of the gold standard, gold discoveries were most likely to occur after a long deflation. What might explain this observation?

After a long period of deflation, an ounce of gold would buy more goods and services. This created a greater incentive to look for new gold deposits.

expansionary fiscal policy abroad

An increase in world interest rate r* lowers real exchange rate and raises NX

According to the Fisher effect, an increase in _______ inflation causes an equal increase in the _________interest rate.

Expected, nominal

Net capital outflow

S-I= net outflow of "loanable funds"

Does S or I depend on real exchange rate?

No NX(epsilon) = S - I(r*)

A newspaper article once reported that the U.S. economy was experiencing a low rate of inflation. It said that "low inflation has a downside: 45 million recipients of Social Security and other benefits will see their checks go up by just 2.8% next year." Is the small increase in benefits a "downside" of low inflation, as the article suggested?

No, as long as inflation is measured correctly, Social Security beneficiaries' purchasing power will not change.

national savings formula

Private savings plus public savings

Trade policy to restrict imports

Raises real exchange rate and S-I, NX stays the same

Expansionary Fiscal Policy Abroad

Raises the world interest rate and lowers Investment while raising NX

Real Exchange rate when there is expansionary fiscal policy at home

Reduces national saving, net capital outflow, and supply of dollars in the market causing REAL EXCHANGE RATE to rise and NX to fall

A country is a borrower when

S < I and when NX < 0

A country is a lender when

S > I

Suppose that instead of a constant money demand function, the velocity of money in this economy was growing steadily due to financial innovation. Assuming everything else was unchanged, how would that affect the inflation rate?

The inflation rate would increase.

real money balances

The quantity of money expressed in terms of the quantity of goods and services it can buy; the quantity of money divided by the price level (M/P).

If real exchange rate rises

U.S. goods become more expensive relative to foreign goods exports fall, imports rise net exports fall

Because most loans are specified in nominal terms, high______inflation hurts____

Unexpected, creditors

The national income identity in an open economy:

Y = C + I + G + NX or NX = Y - (C + I + G)

Private Savings Formula

Y-C-T

which of the following events would cause a currency to depreciate

a rise in the price level

When a person purchases a 90-day Treasury bill, he or she cannot know the: a. ex post real interest rate. b. ex ante real interest rate. c. nominal interest rate. d. expected rate of inflation.

a. ex post real interest rate.

The ex post real interest rate will be greater than the ex ante real interest rate when the:

actual rate of inflation is less than the expected rate of inflation

If nominal wages cannot be cut, then the only way to reduce real wages is by:

adjustments via inflation

Expansionary Fiscal Policy at home

an increase in G and a reduction in T reduces savings and NX is decreased; I is not changed

The concept of monetary neutrality in the classical model means that an increase in the money supply growth rate will increase:

nominal interest rates.

trade surplus

output > spending and exports (x) > imports (IM) size of trade surplus: NX

To end a hyperinflation, a government trying to reduce its reliance on seigniorage would:

raise taxes and cut spending.

An increase in investment demand

raises the interest rate but the equilibrium level of investment cannot increase because the supply of loanable funds is fixed

A decrease in amount of currency

raises the real exchange rate, making the country less competitive in the global markets

Fisher Equation

real interest rate = nominal interest rate - inflation rate

An increase in investment demand

reduces S-I and the supply of dollars in the foreign market, raising real exchange rate and lowering NX

the net exports function

reflects the inverse relationship between NX and real exchange rate NX = NX(epsilon)

Seigniorage

revenue raised by printing money

The larger is the MPC (the closer it is to 1), the _____ will be the decline in investment, and the _____ will be the increase in the interest rate.

smaller; smaller

other things equal, an increase in the world interest rate pushes the trade balance toward_______and causing the currency to__________

surplus, depreciate

how do economists define the 'real interest rate'?

the difference between the nominal interest rate and the rate of inflation

net capital outflow

the excess of domestic saving over domestic investment

real exchange rate

the price of domestic goods relative to foreign goods

nominal exchange rate (e)

the relative price of domestic currency in terms of a foreign currency e.g. yen per dollar

real exchange rate (epsilon)

the relative price of domestic goods in terms of foreign goods e.g. # Japanese Big Macs per U.S. Big Mac

classical dichotomy

the theoretical separation of nominal and real variables

Which is true concerning the relationship between money growth and inflation?

there is a strong correlation between growth in the money supply and inflation

A newspaper article once reported that the U.S. economy was experiencing a low rate of inflation. It said that "low inflation has a downside: 45 million recipients of Social Security and other benefits will see their checks go up by just 2.8% next year." Policymakers link increases in Social Security and other benefits to inflation because:

they wish to ensure that the real value of these benefits is constant over time.

Quantity equation if V is constant

π = %change in M - Real GDP Growth

What is the relationship between the parameter k and the velocity of money?

𝑉=1/𝑘: k is inversely related to velocity, i.e., the more money people hold for a given real income, the smaller velocity is, and vice versa.