Scribd
Upload
114 views5 pages

Solutions - Chapter 3: Macroeconomics II

This document provides exercises and solutions for a macroeconomics chapter on monetary policy. [1] It presents quantitative equations for the relationship between money supply, inflation, GDP, and interest rates. [2] It shows that if money supply increases by 8% and GDP increases by 3%, inflation will be approximately 5%. [3] It also examines how changes in velocity of money or economic growth rates would impact inflation.

Uploaded by

carito
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
114 views5 pages

Solutions - Chapter 3: Macroeconomics II

This document provides exercises and solutions for a macroeconomics chapter on monetary policy. [1] It presents quantitative equations for the relationship between money supply, inflation, GDP, and interest rates. [2] It shows that if money supply increases by 8% and GDP increases by 3%, inflation will be approximately 5%. [3] It also examines how changes in velocity of money or economic growth rates would impact inflation.

Uploaded by

carito
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
You are on page 1/ 5

Solutions - Chapter 3

Macroeconomics II

Professor: Caio Machado ([email protected])


Teaching assistants: Wei Xiong ([email protected]) and Diego Cussen ([email protected])

Last updated: January 15, 2019

Exercise 3.1

According to the quantitative equation (the notation is the same used in class):

Mt V = Pt yt

Mt V
Pt =
yt

Note that we did not add time subscripts to the velocity of money since it is constant.
Taking log’s we can write:

ln Pt = ln Mt + ln V − ln yt (1)

ln Pt−1 = ln Mt−1 + ln V − ln yt−1 (2)

Subtracting (2) from (1):

ln Pt − ln Pt−1 = ln Mt − ln Mt−1 − (ln yt − ln yt−1 )

Macroeconomía II, 2019/1 1


Let ∆Xt ≡ Xt − Xt−1 Since ln X − ln Y ≈ ( X − Y ) /Y we can write:

∆Pt ∆Mt ∆yt


πt = ≈ −
Pt−1 Mt − 1 y t − 1

∆Mt ∆yt
Since Mt −1 = 0.08 and y t −1 = 0.03 we have that inflation is πt ≈ 0.08 − 0.03 = 0.05. To
get the growth rate of nominal GDP (Yt ) we depart from:

Yt = Pt yt

lnYt = ln Pt + ln yt

Iterating it backwards and subtracting from the equation above we get:

∆Yt ∆Pt ∆yt ∆yt


≈ + = πt +
Yt−1 Pt−1 yt−1 y t −1

Therefore, the growth rate of nominal GDP is 0.05 + 0.03 = 0.08 (alternatively, one
could use Mt V = Pt yt = Yt to see that the growth rate of nominal GDP is equal to
the growh rate of Mt ). Using the Fisher equation, we get a real interest rate of r =
0.09 − 0.05 = 0.04.

Exercise 3.2

Item 1

Let M denote the money supply. We can then write P = M/ (κy). Therefore, adding
time subscripts and taking the log’s:

ln Pt = ln Mt − ln κ − ln yt

Macroeconomía II, 2019/1 2


Iterating it backwards and substracting from the equation we get the same relationship
we got in Exercise 3:
∆Pt ∆Mt ∆yt
πt = ≈ − (3)
Pt−1 Mt − 1 y t − 1
∆Mt ∆yt
Therefore, since Mt −1 = 0.12 and y t −1 = 0.04, we get that the inflation rate is 8% per
year.

Item 2

If the real grew at a higher rate, then inflation would be lower, as (3) makes clear. A
higher growth of real GDP increases the demand for real balances, which puts a posi-
tive pressure on the real money supply, lowering prices (everything else constant).

Item 3

The parameter κ captures how sensitive is the demand for real balances to real GDP. In
κ is very large, any increase in real income implies a large increase in the demand for
money. Writing M κ1 = Py, one can see that 1/κ can be interpreted as the velocity of
money. If the velocity of money is very low, any increase in the amount of transactions
people want to make must be fulfilled by a large increase in the real money supply,
since money does not change hands a lot of times.

Item 4

Taking log’s from the quantitative equation we can write:

ln Pt = ln Mt + ln Vt − ln yt (4)

ln Pt−1 = ln Mt−1 + ln Vt−1 − ln yt−1 (5)

Macroeconomía II, 2019/1 3


Subtracting 5 from 4:

ln Pt − ln Pt−1 = (ln Mt − ln Mt−1 ) + (ln Vt − ln Vt−1 ) − − (ln yt − ln yt−1 )

Let ∆Xt ≡ Xt − Xt−1 Since ln X − ln Y ≈ ( X − Y ) /Y we can write:

∆Pt ∆Mt ∆Vt ∆yt


πt = ≈ + −
Pt−1 Mt−1 Vt−1 yt−1

Hence, if ∆Vt > 0 because of financial innovation, we should expect the inflation rate to
increase. Intuitively, if the velocity of money is increasing, people demand less money
for their transactions (since the same dollar bill is being used a lot of times for trans-
actions). For a given nominal money supply, prices will have to increase to guarantee
that the supply of real balances falls, matching the lower demand.

Exercise 3.3

Item 1

Guess a solution of the form (as seen in class, we know that it is a good guess):

pt = m̃ + b0 gt .

Plugging into (1):


 
−b0 gt = −η b0 gt+1 − b0 gt

Solving for g:

1+η
g=
η

Macroeconomía II, 2019/1 4


Thus,
 t
1+η
pt = m̃ + b0
η

is a solution to (1).

Item 2

The idea is for this kind of equilibrium is the following: suppose people expect pt to
rise in the future (b0 > 0). Then, the Fisher equation implies that the nominal interest
rate will be high, reducing agents incentives to hold money. But then, there is too little
money demand for too much money supply, and prices have to increase to equate the
demand and the supply for real balances. But this confirm agents initial expectations
(a self-fullfiling prophecy).

Macroeconomía II, 2019/1 5

You might also like