Intermediate Macroeconomics HW8

Bill Chen (gc2677)

March 28, 2018

1)
a)
Because money growth is constant. Inflation will be equal to the rate of
money supply expansion due to rational expectations. Therefore, the Fischer
equation yields a constant interest rate. The demand function for real money
will therefore constant. Therefore, the rate of growth of P will be equal to the
growth rate of money supply which is 1%.
b)
Using fischer’s equation
i=π+r
Since µ = π
r = i − µ = 3 − 1 = 2%
2)
Fischer’s eq:
(1 + it ) = (1 + r)(1 + Et πt+1 )

Et πt+1 = i − r = 2%

3)
a)

Mt Y
= L(it , Yt ) =
Pt 1 + it

M0 Y
=
P0 1 + i0

115
P0 = 100 ∗ 1.15/Y =
Y
b)
Fischer’s Eq:
(1 + it ) = (1 + r)(1 + Et πt+1 )

1
 it = r + Et πt+1

15% = 4% + Et πt+1

We can see that the expected inflation is 11%.

c)
M1 Y
=
P1 (1 + r1 )(1 + E1 π2 )

E1 π2 = µ = 2%

Plugin the real interest rate, P0 calculated from before, M1 the expected
future inflation into the following:
P1 (1 + r1 )(1 + E1 π2 )M1
π1 = −1= − 1 = −4.07%
P0 115
Our expected inflation from period 0 for period 1 is 11% but our actual
inflation is actually a deflation of 4.07%.
4)
Simply use the previous equation but plugin

E0 π1 = E1 π2 = 11%

into the following equation, while all else remain the same:
P1 (1 + r1 )(1 + E0 π1 )M1
π1 = −1= − 1 = +4.40%
P0 115
5)
a) Current price level depends on both current and expected future money
supplies.
b) Price level changes by the same amount which the money supply changes.
c) Price level also changes by the same amount which the growth rate of the
money supply changes times by the constant γ.
d) mt will have to go up to mitigate the reduction in µ. However, this could
reduce the interest rate as well, which will means this mathematical model can’t
paint the complete picture of how much we would need to increase the money
supply by.
e) Then any changes in the growth rate of money will not have an effect on
price level. Price level still changes by the same amount by which the current
money supply changes byt will not be affected by any changes in µ, hence we
do not need to raise the current money supply if we were to reduce µin order to
maintain a constant price level.