Name: Answer Key EC 391 Midterm #2 Short Answer 1) What is the difference between a credit driven asset price bubble and an irrational exuberance asset price bubble. A Credit driven butble io tapid gfowts in Consumer and busines cit to + a ineece higher ond Pony and Twerment Shevdin the cetre credit UG TavestMonst ond — ConSumpbin dewond vw pwurd raising er ART ede Trident edwdennce 1S on incense ia demand ty asters Smnsed VY Sa x as Which en cowye ii vest MY oyholeg ical Prenssure S FO Wgmre — Landaa) Value OF He ass art New that pric wit) Reap ising. 2) What are the benefits and disadvantages of the unconventional monetary policy tool of forward guidance? Rath Forward guidsnce owllings a CBR oF Mercy Polity ter tony duution of Hime, Forward Quidence. Signals trot — iMleray rales will femain lew fr aw Sigmticunt When of ime, ThiS herp wer Chord- term and (Malin term needs (25. Noyever this alse Sigrals that dhe Cond! : f PS AC: tigi Ing lation ond weaK - eConomic guts He Sign't icant futule and can Mibigarle the Sion tages OF layer inteleat Maks gn investment froiects 3) What are the advantages and disadvantages of an inflation-target law? Taftetion Aagets fie the Hime = in canc taney oF discretionary Tene Bley. Tahun tagets Wake the fate il Of Meresr Cares predictable and Unders turd abe othe “ grdiic. However in diate als peel ' in Hatin day geko . ee eke Pied vrable te forck tp business, SAREE Goes.Analytical Questions 1) Demand and Supply of Reserves: For each of the following graph the initial eq. and the effect of the policy change. Describe the change of the equilibrium federal funds rate. a) Suppose the discount rate is equal to the initial federal funds rate. Graph a decrease in the discount rate. > z Fed Funds I PR Resert 5 b) Suppose the initial federal funds rate is between the discount rate and interest rate paid on reserves. Graph a decline in demand for reserves. gg eat? fa fuss | NBR Reserves, ©) Suppose the discount rate is equal to the initial federal funds rate, Graph an increase in the discount rate. Does borrowed reserves increase or decrease? Jar (es wera : fee Funds eR | Rotfowed Reserves Decrenses fine et oy aR Resewes, 4d) Suppose the initial federal funds rate is between the discount rate and interest rate paid on reserves. Graph a decline in the interest rate paid on reserves. No Ghat ye in : the oy, Fab Faris Rate, Pesce2) ISMP Algebra Y=C+I4+G4NX C=C +mpc(¥ -T) NX = NX r= F+An+o(¥ —¥) -(MP Curve) a) Intuitively explain each element of the MP curve equation. ey hee MP Care Mow teacts to inflation und He ae SP 0 is ae Sensiaisity in Which 7 chanyes in 3 Change in the our pub oy fre: t,) ‘b) Solve for the IS curve? Ye Ze age cy-1) 4 F 3 (ret) +B 4K Yon - a forme 2 SE tO HK mr Yo Le sme? ef at themj st _ 4 Vee Sie c) Solve for the AD curve? Ye Lo -mpeF +3 ait 33 +a] ee A ae Tempe Y 422 ee tre Lome oP oak tp hy od oe <= : ('+22,) 7 : Ree ee Ie mpc +40 Ve Pe ae Vetere 1 2 _ ted +E -3F 40 We rate do ~twpardg LT ttt -of] Lrern sou3)_IS-MP-AS/AD Graphs a. Inthe 1990's the United States experienced permanent technology shocks and accommodating monetary policy. Drawing the IS, MP and AS-AD graphs describe this story. Assume the macroeconomy was initially at a long-run equilibrium. ) the a ll whe Leas ound Sh. Cheol Sheors Shille Stew ahi Ke Nols ase lett ee Dae ccnekin Pelvs wove now and Gustaln cd Be Mp Ned Metetory policy were Fant Shifts curve down ay “AO out ~Datending on the Cite ob “aye chooks the, SOOMMY, weve lower “ eu raid eer ee Ve. acts Sosidve cttdut gap Wetec of he SecSde. What OW a . The econcity experienced's postive output Be would we expect to see happen to the expected inflation rate because of this? Eige pied weFunbion weaid cise with A PSitive ouput BaP. i, What if the short run aggregate supply curve did not depend on the output, gap (low gamma), would this accelerate or decelerate the answer you gave inparb. 42 owteat Gap wraw mot Mfacr te RAS Gre Causing = Sail change ™ oHe 4d ‘ation and Slowing down tre OES ow new IR ly from the permanent techs Shuck,Le Choice 1) The opportunity cost of holding excess reserves is the federal funds rate A) minus the discount rate. B) plus the discount rate. plus the interest rate paid on excess reserves. ) jninus the interest rate paid on excess reserves. 2) When the federal funds rate equals the interest rate paid on excess reserves ‘A) the supply curve of reserves is vertical. B) the supply curve of reserves is horizontal. C) the demand curve for reserves is vertical D))the demand curve for reserves is horizontal. 3) Monetary poliey is considered time-inconsistent because ‘A) of the lag times associated with the implementation of monetary policy and its effect on the economy. B) policymakers are tempted to pursue discretionary policy that is more contractionary in short run. (pts are tempted to pursue discretionary policy that is more expansionary in short run. D) of the lag times associated with the recognition of a potential economic problem and the implementation of monetary policy. 4) Because prices are st rate cky in the short-run, when the Federal Reserve raises the federal funds A) nominal interest rates fall. real interest rates rise. flation falls. D) real interest rates fall. '5) The monetary policy (MP) curve indicates the relationship between ‘A) the Federal Funds Rate and the real interest rate, B) the Federal Funds Rate and the inflation rate. the inflation rate and the expected inflation rate. Oye real interest rate the central bank sets and the inflation rate. 6) Trye-or False: Every time the IS curve shifts, the AD curve shifis in the same direction? A) JIrue False7) Everything else held constant, an increase in financial frieti increases; demand @)atorass demand ‘ decreases; supply D) increases: supply aggregate 8) Everything else held constant, an increase in net taxes will cause the IS curve to shift to the and aggregate demand will A) right: increase B) right; decrease ©) lef; increase ple: decrease 9) Everything else held constant, if firms expect an increase in inflation, _aggregate supply ‘A) long-run; increases B) long-run; decreases ac