* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
Download Econ 201 Intermediate Macroeconomics
Survey
Document related concepts
History of the Federal Reserve System wikipedia , lookup
Yield spread premium wikipedia , lookup
Internal rate of return wikipedia , lookup
Lattice model (finance) wikipedia , lookup
Pensions crisis wikipedia , lookup
Financialization wikipedia , lookup
Interbank lending market wikipedia , lookup
Monetary policy wikipedia , lookup
Continuous-repayment mortgage wikipedia , lookup
Adjustable-rate mortgage wikipedia , lookup
Credit rationing wikipedia , lookup
History of pawnbroking wikipedia , lookup
Present value wikipedia , lookup
Transcript
Econ 201 Intermediate Macroeconomics Assignment 2 - Solution (Chapter 14, 15) 1. Label each of the following statement true, false, or uncertain. Explain briefly. a) The real interest rate is equal to the nominal interest rate divided by the price level. FALSE. b) The price of one-year bond increases when the nominal one year interest rate increases. FALSE. c) The value today of a nominal payment in the future cannot be greater than the nominal payment itself. TRUE. Nominal interest rates cannot be negative, but real interest rates can. d) Worries about future inflation would tend to make the yield curve slope down. FALSE. Future short-term nominal interests are expected to increase. So the yield curve should be upward sloping. e) An equal increases in expected inflation and nominal interest rate at all maturities should lead to a fall in stock prices. FALSE. f) A rational investor should never pay a positive price for a stock that will never pay dividends. FALSE. Rational Speculative Bubble. 2. Question 3 of Chapter 14 in the textbook. a. No. If the nominal interest rate were negative, nobody would hold bonds. Money would be more appealing since it could be used for transactions and would earn zero — as opposed to negative — interest. b. Yes. The real interest rate is negative if expected inflation exceeds the nominal interest rate. Even in this case, the real interest rate on bonds (which pay nominal interest) exceeds the real interest rate on money (which does not pay nominal interest) by the nominal interest rate. c. A negative real interest rate makes borrowing very attractive and leads to a large demand for investment. d. Answers will vary. 3. Question 8 of Chapter 14 in the textbook. a. The IS shifts right. At the same nominal interest rate, the real interest rate is lower, so output is higher. 1 b. The LM shifts right. c. Output increases. The nominal interest rate is higher than in Figure 14-5. Whether the nominal interest rate is lower or higher than before the increase in money growth is ambiguous. Thinking in terms of the money market equilibrium, the increase in the nominal money supply tends to reduce the nominal interest rate, but the increase in nominal money demand (because of the increase in output) tends to increase the nominal interest rate. d. Output is higher than in Figure 14-5. Reasoning from the IS relation, the real interest rate must be lower, since no exogenous variables in the IS relation have changed. (In other words, while the nominal interest rate may increase relative to Figure 14-5, it increases by less than the increase in expected inflation. So the real interest rate decreases.) 4. Question 2 of Chapter 15 in the textbook. $F 2000 a. $ P = ⇒ 1700 = ⇒ i = 4.15% n (1 + i ) (1 + i ) 4 2000 b. 1700 = ⇒ i = 3.30% (1 + i ) 5 2000 c. 1750 = ⇒ i = 2.71% (1 + i ) 5 5. Suppose the yield curve is initially upward sloping. Use your knowledge of the IS-LM model and the yield curve to explain what effect each of the following events will have on the shape of the yield curve. a) Financial markets expect a future reduction in consumer confidence which results in a reduction in consumer spending. A reduction in consumer spending will cause the IS curve to shift left and the interest rate to fall. The expected future one-year rate will fall causing the yield curve to become flatter. b) Financial markets expect a future Fed monetary expansion. A monetary expansion will cause the LM curve to shift right. The expected future one-year rate will fall causing the yield curve to become flatter. c) Financial markets expect a future reduction in government spending which is accompanied by a Fed monetary expansion. A reduction in government spending will shift the IS curve to the left and a monetary expansion will shift the LM curve to the right. The expected future one-year rate will fall causing the yield curve to become flatter. d) Financial markets expect a future tax cut. 2 A tax cut will shift the IS curve to the right due to the increase in the disposable income of consumer. The expected future one-year rate will increase causing the yield curve to become steeper. 6. Question 8 of Chapter 15 in the textbook. a. The Fed can reduce the growth rate of money. The nominal interest rate increases in the short run, but falls in the medium run. b. Inflation was highest in early 1980. The 12-month inflation rate peaked at 14.6% in March and April of 1980. c. (graph) d. A positive spread means that expected future interest rates are higher than current interest rates. A declining spread means that the expected increase in future short-term interest rates is falling. The one-year T-bill rate increased from 7.28% to 12.6% between January 1978 and January 1980, but the spread declined from 0.9 percentage points to –1.46 percentage points over the same period. Financial market participants were not expecting short-term interest rates to continue to increase. Indeed, by the end of the 1970s, the negative spread indicates that short-term interest rates were expected to decline in the future. e. There spread declined by almost one percentage point in October 1979. The decline is consistent with expectations of lower inflation in the future. f. The one-year interest rate fell. g. During the rate cut in the recession, spreads went up, as short-term rates declined. However, long-term rates did not increase, which suggests that inflation expectations did not increase. Instead, the increase in spreads is consistent with the expectation that the anti-inflationary policy would continue with high short-term interest rates after the recession. This is indeed what happened. 3 7. 4 5