Flashcards
Week 2 - Applied Macro
Cards in this deck (12)
- 1Explain whether it is possible for the nominal interest rate to increase while the real interest rate simultaneously decreases.Answer: The nominal interest rate is determined in financial markets. The real interest rate is approximately equal to i - πe where πe is expected inflation. When i increases, r can fall if the increase in expected inflation exceeds the rise in i.
- 2First, explain what the nominal interest rate represents. Second, explain what the real interest rate represents.Answer: The following expressions, where i the nominal interest rate, represents the amount of dollars one must repay in the future in exchange for borrowing one dollar today: 1 + i. Therefore, i represents the cost of borrowing dollars in terms of dollars. The following expressions, where r the real interest rate, represents the amount of goods one must repay in the future in exchange for borrowing one unit of a good today: 1 + r. Therefore, r represents the cost of borrowing goods in terms of goods.
- 3Using the IS-LM model, graphically illustrate and explain what effect an increase in money growth will have on output, the nominal interest rate, and the real interest rate in the short run.Answer: An increase in money growth will cause the LM curve to shift down. This will lower the nominal rate. Assuming expected inflation does not change, the real rate will fall by the same amount. Investment will increase causing an increase in demand and output. For the graph, refer to the slides.
- 4Explain what effect monetary policy will have on the nominal interest rate in the short run and in the medium run.Answer: The central bank can affect the nominal interest rate in the short run. That is not the case in the medium run. In the medium run, the nominal rate will equal the natural real rate plus inflation. The central bank cannot affect the real rate; however, by altering money growth, the central bank can affect inflation. So, by changing the rate of growth of M, the central bank can indirectly affect the nominal rate in the medium run.
- 5Explain what effect monetary policy will have on the real interest rate in the short run and in the medium run? Explain.Answer: The real rate in the medium run is determined by real factors. The central bank cannot change the real rate in the medium run. It is possible for monetary policy to affect the real interest rate in the short run, however.
- 6Explain what the Fisher effect/Fisher hypothesis represents.Answer: The Fisher effect represents the relationship between expected inflation and the nominal interest rate. As expected inflation increases, the nominal interest rate will tend to rise.
- 7To reduce the nominal interest rate in the short run, what type of policy should the central bank pursue? Explain.Answer: The central bank most likely should pursue expansionary monetary policy. This will depress i as long as expectations of inflation do not change significantly.
- 8To reduce the nominal interest rate in the medium run, what type of policy should the central bank pursue? Explain.Answer: To depress i in the medium run, the central bank must reduce money growth to reduce inflation. As inflation falls, i will fall.
- 9Using the IS-LM model, graphically illustrate and explain what effect a reduction in money growth will have on output, the nominal interest rate, and the real interest rate in the short run.Answer: A reduction in money growth will cause the LM curve to shift up. This will increase the nominal rate. Assuming expected inflation does not change, the real rate will rise by the same amount. Investment will decrease causing a reduction in demand and output.
- 10Using the IS-LM model, graphically illustrate and explain what effect a reduction in expected inflation will have on the IS and LM curves in the short run.Answer: A reduction in expected inflation will cause the IS curve to shift to the left. LM curve will stay the same.
- 11Using the IS-LM model, graphically illustrate and explain what effect an increase in expected inflation will have on the IS and LM curves in the short run.Answer: An increase in expected inflation will cause the IS curve to shift to the right. LM curve will stay the same.
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- Flashcards on Week 2 - Applied Macro, created by Steven Knight on 04/08/2016.
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- Steven Knight
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