Provide an answer and a short (2-3 sentences) explanation for each of the following questions related to the quantitative easing measures.
a. If long-term interest rates and future short-term interest rates increase, what is a reasonable change of the current short-term interest rates?
b. What was the reason for widening of corporate spreads after big bankruptcies in 2007/08?
c. Why does an increase in the interest rates pose a threat to Fed's balance sheet following quantitative easing interventions?
Determine the effects of each of the following shocks on income, the interest rate, consumption, and investment using the IS-LM model. In each case, explain what the Central Bank should do to keep income at its initial level.
a. After the invention of a new efficient drug, many pharmaceutical firms decide to conduct research in this area and make additional investment into equipment.
b. A wave of credit-card fraud increases the frequency with which people make transactions in cash.
c. Households decide to increase the percentage of their income devoted to saving.
Consider an economy with consumption given by C = 300 + 0.6Y D , where Y D is disposable income. The income tax is T = 0.2Y . Investment are described by I = 200 + 0.2Y - 1000i. Government spending is G = 200. The money demand follows MD/P = 0.5Y - 2500i and real supply is fixed MS/P = 500.
a. Find an equation for the IS curve.
b. Find an equation for the LM curve.
c. Solve for equilibrium output Y and the equilibrium interest rate i. Depict the IS/LM model.
d. Solve for the equilibrium levels of consumption C and investment I.
e. Now assume that the government decides to increase the tax rate τ to 60%, calculate what happens to the equilibrium values of Y, i, C and I.
f. Setting all variables back to their original levels, calculate the new equilibrium values for Y, i, C and I if the Central Bank increased the money supply from 500 to 600.
Explain why each of the following statements is true. Discuss the impact of monetary and fiscal policy in each of these special cases.
a. If investment does not depend on the interest rate, the IS curve is vertical.
b. If money demand does not depend on the interest rate, the LM curve is vertical.
c. If money demand does not depend on income, the LM curve is horizontal.
d. If money demand is extremely sensitive to the interest rate, the LM curve is horizontal.
Suppose that the labor force is fixed at 10 million people, of whom 1 million are unemployed. Assume that the job-separation rate is 2% per month and the job-finding rate is 40% per month.
a. Trace out (numerically and graphically) the time path of employment and unemployment during the first two years.
b. What is the natural unemployment rate?
Suppose that economic fluctuations are caused by shocks to the technology level.
a. What do you predict for the cyclical behavior of job vacancies?
b. How then would fluctuations in vacancies relate to fluctuations in the unemployment rate?
Suppose that the government replaces the existing monetary unit with a new one. For example, Canada might shift from the old dollar to the Harper dollar, defined to equal 10 old dollars. People would be able to exchange their old currency for the new currency at the ratio of 10 to 1. Also, any contracts that were written in terms of old dollars are reinterpreted in Harper dollars at the ratio 10 to 1.
a. What happens to the price level, P, and the interest rate, i?
b. What happens to real GDP, Y , consumption, C, and labor, L?
c. Do the results exhibit the neutrality of money?