Eco 305: Ch 5 practice problems

If the real return on government bonds is 3 percent and the expected rate of inflation is 4 percent, then the cost of holding money is ______ percent.

7 The nominal return will be the opportunity cost Nominal return equal to real return plus inflation So the opportunity cost is 3+4=7℅

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.

The quantity equation for money, by itself:

may be thought of as a definition for velocity

All of the following are costs of fully expected inflation except that expected inflation:

causes lower real wages

The rate of inflation is the:

percentage change in the level of prices

When the demand for money parameter, k, is large, the velocity of money is ______ and money is changing hands ______

small; infrequently

If the nominal interest increases, then

the demand for money decreases

In the classical model, according to the quantity theory and the Fisher equation, an increase in money growth increases:

the nominal interest rate.

The right of seigniorage is the right to:

to print money

The quantity theory of money assumes that:

velocity is constant.

Percentage change in P is approximately equal to the percentage change in:

M minus percentage change in Y plus percentage change in velocity

If the demand for money depends positively on real income and depends inversely on the nominal interest rate, what will happen to the price level today, if the central bank announces (and people believe) that it will decrease the money growth rate in the future,but it does not change the money supply today?

People will expect lower inflation in the future. The nominal interest rate will fall. Money demand will increase. Since the central bank does not immediately decrease the money supply, prices must fall to keep the newly increased money demand equal to the constant money supply. Thus, current prices fall as a result of expected future decreases in money growth rates.

The one-to-one relation between the inflation rate and the nominal interest rate, the Fisher effect, assumes that the:

real interest rate is constant.

Inflation ______ the variability of relative prices and ______ allocative efficiency

increases; decreases

If the real interest rate and real national income are constant, according to the quantity theory and the Fisher effect, a 1 percent increase in money growth will lead to rises in:

inflation of 1 percent and the nominal interest rate of 1 percent

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

inflation.

The income velocity of money:

is defined in the identity MV = PY

According to the classical theory of money, inflation does not make workers poorer because wages increase:

in proportion to the increase in the overall price level.

The demand for real money balances is generally assumed to:

increase as real income increases.

If there are 100 transactions in a year and the average value of each transaction is $10, then if there is $200 of money in the economy, transactions velocity is ______ times per year

5 the equation of exchange is MV=PY M=money supply, V=velocity, P=price level Y=real GDP= transactions V=PY/M V=(10*100)/200 => V=5 the velocity is 5

If the quantity of real money balances is kY, where k is a constant, then velocity is:

1/k

If the average price of goods and services in the economy equals $10 and the quantity of money in the economy equals $200,000, then real balances in the economy equal:

20,000 MV = PY M= money , V= velocity, P= price, Y= output Real balances at velocity = constant can be represented as M/P = Y/V Y = 200,000/10

If the money supply increases 12 percent, velocity decreases 4 percent, and the price level increases 5 percent, then the change in real GDP must be ______ percent

3 M x V = P x Y, where M" Money supply, V: Velocity, P: Price level, Y: Real GDP. Therefore, % Change in M + % Change in V = % Change in P + % Change in Y 12% - 4% = 5% + % Change in Y 8% = 5% + % Change in Y % Change in Y = 8% - 5% = 3%

According to the quantity theory 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_____.

5; 5

In the long run, according tothe quantity theory of money and the classical macroeconomic theory, if velocity is constant, then ______ determines real GDP and ______ determines nominal GDP.

the productive capability of the economy; the money supply

A rate of inflation that exceeds 50 percent per month is typically referred to as a(n):

hyperinflation

The costs of reprinting catalogs and price lists because of inflation are called:

menu costs

The definition of the transactions velocity of money is:

prices multiplied by transactions divided by money.

Consider two countries, Hitech and Lotech. In Hitech new arrangements for making payments, such as credit cards and ATMs, have been enthusiastically adopted by the population, thereby reducing the proportion of income that is held as real money balances. Over this period no such changes occurred in Lotech. If the rate of money growth and the growth rate of real GDP were the same in Hitech and Lotech over this period, then how would the rate of inflation differ between the two countries? Carefully explain your answer.

The rate of inflation would be higher in Hitech. According to the quantity theory, if the rates of money growth and real GDP growth rates are the same, differences in rates of inflation are related to differences in velocity. An increase in velocity leads to a higher rate of inflation, holding other factors constant. In Hitech the reduction in the proportion of income held as real balances (smaller k) is the equivalent of an increase in velocity and, consequently, a higher rate of inflation in Hitech than in Lotech

If the transactions velocity of money remains constant while the quantity of money doubles, the:

price of the average transaction multiplied by the number of transactions must double.

Using average rates of money growth and inflation in the United States over many decades, Friedman and Schwartz found that decades of high money growth tended to have ______ rates of inflation and decades of low money growth tended to have ______ rates of inflation.

high; low

If the nominal interest rate is 1 percent and the inflation rate is 5 percent, the real interest rate is:

-4 percent Real interest rate = Nominal interest rate - inflation rate = 1 - 5= -4%

In classical macroeconomic theory, the concept of monetary neutrality means that changes in the money supply do not influence real variables. Explain why changes in money growth affect the nominal interest rate, but not the real interest rate

According to the Fisher equation, the nominal interest rate equals the real interest rate plus the expected rate of inflation. The expected rate of inflation depends on the rate of money growth, so the nominal interest rate depends on the rate of money growth. According to classical macroeconomic theory, the real interest rate adjusts to bring the level of saving and investment (both real variables) into equilibrium without reference to the rate of money growth.

Assume that a series of inflation rates is 1 percent, 2 percent, and 4 percent, while nominal interest rates in the same three periods are 5 percent, 5 percent, and 6 percent, respectively. a.What are the ex post real interest rates in the same three periods? b.If the expected inflation rate in each period is the realized inflation rate in the previous period, what are the ex ante real interest rates in periods two and three? c.If someone lends in period two, based on the ex ante inflation expectation in part b, will he or she be pleasantly or unpleasantly surprised in period 3 when the loan is repaid?

a.4 percent; 3 percent; 2 percent b.4 percent; 4 percent c.He or she will be unpleasantly surprised

Inflation tax" means that:

as the price level rises, the real value of money held by the public decreases.

If the Fed announces that it will raise the money supply in the future but does not change the money supply today

both the nominal interest rate and the current price level will increase.

The real interest rate is equal to the

nominal interest rate minus the inflation rate.

The general demand function for real balances depends on the level of income and the:

nominal interest rate.

The opportunity cost of holding money is the:

nominal interest rate.