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B Short answer (25 marks total). Answers should typically be no more than 2-3 sentences in length.

1. (5 marks) Consider the long-run model of chapter 4, and suppose inflation increases. How might this affect demand for real money balances? Explain.

2. (5 marks) Define the ex ante and ex post real interest rates, and explain why they might be different.

3. (5 marks) What is the difference between the nominal interest rate and the real interest rate? As part of your answer, define these two interest rates.

4. (5 marks) In our model of chapters 9-10, we said that output was “supply-determined” in the long run, but “demand-determined” in the short run. Explain in your own words what this means.

5. (5 marks) Explain why the IS curve is downward-sloping using the goods-market approach.

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Ronald
RonaldLv2
28 Sep 2019

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Related questions

A. True or false (9 marks total) For each of the statements in Section A, determine whether it is true or false, then explain in a few sentences why that is the answer. Note: no marks will be given for answers that do not include an explanation.

1. (3 marks) In practice, the Bank of Canada sets a target for real money balances and then the interest rate automatically adjusts to ensure this target is met.

2. (3 marks) In the Mundell-Fleming model, in general the level of domestic investment could depend both on foreign and domestic economic conditions.

3. (3 marks) The Solow model attempts to explain growth in output over the very long run through increases in the capital stock, reductions in the unemployment rate, and increases in technology.

Suppose John borrows $100 from Jane for one year at a fixed nominal interest rate. Suppose John and Jane both agree that the ex-ante real interest rate on the loan should be 3%.

a) What will be the nominal interest rate on the loan according to the Fisher Equation, if the expected inflation rate over the next year is:

5 percent? 3 percent? 0 percent? -2 percent? -4 percent? -6 percent?

b) If there is a zero lower bound on interest rates, what will the nominal interest rate actually be when expected inflation is equal to:

-4 percent or -6 percent?

What will the ex-ante real interest rate be in those cases?

c) Explain why deflation can be disruptive to credit markets and the economy (which is why monetary policymakers try to avoid deflation by making sure the money supply grows over time).

Suppose I borrow $200,000 for one year at a fixed nominal interest rate of 7 percent.

(a) What is my nominal repayment next year?

(b) Suppose that at the time the loan was made, both the lender and I believed that the (ex-ante) rel interest rate on the loan would be two percent. Suppose the actual inflation rate over the life of the loan turns out to be 4 percent. What is the ex-post real interest rate? Does the inflation rate help me at the expense of the lender, or help the lender at my expense?

(c) Re-do question (b) assuming that the inflation rate turns out to be 5 percent and 6 percent.

(d) Given that the lender and I agreed that the ex-ante real interest rate should be 2 percent, what nominal interest rate would I have been charged if the lender and I had expected inflation over the life of the loan to be 10 percent? 3 percent? 0 percent?

(e) Inflation increased enexpectedly during the 1970s. Explain why this helped someone who bought a house using a 30-year mortgage with fixed nominal interest rates in 1965, but not someone who bought a house using a 30-year mortgage with a fixed nominal interest rate in 1980.

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