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Monetary Economics 2nd Edition Jagdish Handa - Solutions
Given the stylized facts on money in Chapter 21, how far does the MIUF approach(i) without time and overlapping generations, (ii) with overlapping generations, satisfy the items in the list (a) that you specified in answer to the preceding question?In answering (i), you may, if you want, use the
Some economists have claimed that the OLG model of fiat money includes what is essential for a good theory of money and that it should be recognized as the best available one. Draw up a list of (a) what you consider to be essential for a good theory of money, and (b) the policy implications of the
Which of the following approaches to money demand do you prefer: (a) MIUF,(b) indirect MIUF, (c) cash-in-advance, or (d) pure OLG models of money? Why?
Assuming full employment, does the Wallace–Modigliani–Miller theorem hold in the IS–LM and AD–AS models? Discuss.
Compare the assumptions and implications of the OLG models of this chapter with the IS–LM and AS–AD models for (a) exogenously given endowments of commodities and without labor explicitly in the analysis; (b) the labor market and production functions of the type usually assumed in the IS–LM
Given the information in the preceding question related to the model in Section 22.4, would this economy always maintain full employment (at a positive real wage)? If not, derive the rate of unemployment as a function of the money growth rate.
For the production and utility functions specified in Section 22.4 and zero population(equal to labor force) growth, examine the consequences of serious deflation for the average productivity of labor, employment and output. Is money neutral?
What is the impact in theOLGmodel with money of competitively created substitutes for fiat money by private commercial banks? What is the impact of innovations in banking technology, such as ATMs?
Compare the relationships between money, saving and wealth in the asic OLG model with money with those in the IS–LM and AD–AS models.
What does M1 do in the real-world economies? What do bonds do? Why are they not perfect substitutes for the ordinary individual? Discuss some of the ways in which the OLG models with money might be modified to introduce bonds that are not perfect substitutes for M1 and capture the roles that you
Given the stylized empirical facts about money in the economy, discuss the validity of the benchmark OLG model. If its implications are drastically at odds with the stylized empirical facts, should it be retained? If so, on what grounds?
Discuss in the context of the OLG model the validity of Friedman’s money supply rule:the best monetary policy is one that increases the money supply at a steady low rate.
Discuss the statement: the uniqueness of monetary equilibrium with perfect foresight in the basic OLG model with money requires implausible conditions.
Discuss the statement: money will have no value if there is a terminal date for the economy.
The assumption in many, if not most, macroeconomic models is that firms do not save but borrow (through the issue of one-period bonds) each period the funds that they need for investment. Under this assumption, if fiat money is intrinsically useless for firms, its demand by firms will be zero under
In the OLG framework, assume that the incomes in the (one-commodity) economy are paid to workers in the form of the commodity by the representative private firm, with full employment in the economy. Assume that each worker produces one unit of the commodity (without requiring physical capital).
For the fiat money in your country, what would be the arguments and signs of the partial derivatives of its demand function, according to: (a) the OLG model of this chapter;(b) your knowledge of the economy and the empirical literature on it?
Experience indicates that in the real world, several fiat monies – for example, the Canadian and US dollars in Canada – can coexist in the economy with positive values even when there are no legal barriers to the use of each one. Further, each has its own determinate demand function, quite
In the OLG framework, assume that the economy has N persons born each period, each person lives two periods, each young person supplies one unit of labor and saves a constant proportion of income. The old do not supply labor, nor do they save. During each period the economy’s saving can be held
For the OLG model, you are given the utility function of the representative young as:U(.) = ln c y t +δ ln co t+1 For a given population and given endowments of the commodity in the two periods, derive the demand functions for the commodity, the price level and the rate of return on nominal
For the benchmark OLG model, show and discuss the welfare implications of monetary expansion that ensures price stability, along with those of monetary stability that results in price deflation.
Specify and discuss at least five stylized facts about money in the economy.
For two-period bonds, show that the expectations hypothesis approximately implies that:R2 = ½r1 +½1re 2where R and r are the logs of the relevant gross rates.It is sometimes claimed that long rates overreact to current short rates because financial markets are “myopic.” Define what you
“The theory of portfolio selection has little relevance for explaining the demand for money. Its real relevance is to the theory of bond and equity returns and prices.” Discuss.Show how it can be used to explain these returns and prices.
For the derivation of the expected future inflation rates from the yield curve, is it really valid to assume (a) a constant real rate of interest, (b) a constant liquidity premium per period? Cite some studies that have done so, and report on their findings.What are the determinants of the real
How does the inability to establish the yield curve for the real rate of interest affect the derivation of the future expected rates of inflation from the nominal interest rates?Does the existence of a term structure of liquidity premiums pose corresponding problems?
Use your data on the yield curve to derive the expected rates of inflation monthly over the next twelve months and annually over the next five years. What assumptions were needed for this derivation? If the actual inflation rates turn out to differ from your computed ones, how would you explain the
Assuming that the expectations theory of the yield curve is correct, derive from your data on the yield curve the expected future spot rates for the next twelve months.If your economy has forward markets for this period, compare the forward short rates with your derived expected future spot rates,
For your country, what is the current shape of the yield curve? Explain this shape.
Can the central bank change the shape of the yield curve through changes in (a) the term structure of government bonds and (b) variations over time in monetary aggregates?Discuss.
“On the basis of recent empirical studies, the expectations hypothesis with efficient markets and rational expectations does not seem to explain the term structure of interest rates.” Discuss. Present the findings of at least one such study and discuss the potential reasons for this failure.
The yield curve shows the relationship between the yields of high-grade securities that differ only in the term to maturity. Sometimes the curve rises, sometimes it falls and sometimes it is flat. Present the main reasons for these different shapes.
Are the loanable funds and liquidity preference theories of the rate of interest consistent with (i) interest rate targeting, (ii) the Taylor rule? If not, how can they be made consistent?
Why does the real interest rate fluctuate over the business cycle? Can monetary factors change it? Discuss.
Is there a “natural” rate of interest? What does it mean and what determines it? Is there a curve such as the Phillips curve for the real rate of interest? Discuss.
“The real rate of interest is a real variable. Under rational expectations, it is invariant to systematic changes in the money supply or the price level. However, unanticipated changes in these nominal variables can change the real rate of interest.” Discuss this statement in the context of the
Do the existence and operations of financial intermediaries have any implications for the rate of interest? If so, are these adequately reflected in the short-run macroeconomic models, and in what ways?
“The assumption of modern classical economics that there exists continuous labor market clearance at full employment means that we can confine the analysis of the real rate of interest to states of general equilibrium and ignore its properties for the disequilibrium states. Therefore, it does not
Dynamic adjustments occur in disequilibrium but Chapter 18 raised doubts about the applicability of Walras’s law if there was disequilibrium in the commodities and labor markets. In this context, should the dynamic analysis of interest rates be conducted with notional or effective excess demand
Is there some relationship between the assertions (a) on buffer stock money holdings and (b) that in the real-world economies there is no explicit market in the economy for money but that it is a reflection of the other markets? Discuss.
The buffer stock analysis of the demand for money in Chapter 6 asserted that money acts as a buffer during periods in which economic agents need to adjust their stocks of other goods (commodities, bond and labor) to their optimal levels, but that such adjustments are more costly in the short term
This chapter has made the rather unusual assertion that in real-world economies there is no explicit market for money. Instead, the money market is a reflection of the other markets. Do you agree or disagree? Give reasons for your answer. What does your answer imply for the theory relevant to the
Monetary theory implicitly assumes that the interest rates and the money stock are uniquely linked so that changes in one have a corresponding counterpart in the other, so that it does not matter which one the central bank chooses to change. What assumptions are needed for this assertion? Are they
Can the central bank change the interest rate in the economy through changes in its discount/bank rate? Present the analysis and theory relevant to your answer for the economy you live in.
Discuss the adjustment process likely to follow a change in (a) the money supply through open market operations, (b) a cut in the central bank’s discount rate, leading to eventual changes in the interest rates in the economy.
Keynes asserted that there is no such thing as a non-monetary theory of the rate of interest and that the rate of interest is uniquely determined by the demand and supply of money.Explain Keynes’s reasons for this view. Compare this view with those of the traditional classical and modern
Compare and contrast the liquidity preference and loanable funds theories of the rate of interest. Discuss their implications for monetary policies intended to maintain full employment.
Explain how the monetary and real factors enter into the determination of the interest rates in the short run and in the long run.
Define the notional, Clower and Drèze demand and supply functions. Prove whether or not Walras’s law applies to each of these three types of functions and in what sense it does so.
Robert Clower argued that “either Walras’s law is incompatible with Keynesian economics, or Keynes had nothing fundamentally new to add to orthodox economic theory.” Is Walras’s law incompatible with the different Keynesian and neoKeynesian models as they have evolved?
Discuss: “The derivation using Walras’s law of the excess demand function for bonds from those of other markets provides insights into its properties and also shows some clearly invalid assumptions usually made for the excess demand and supply functions for the other markets”. Illustrate with
Discuss: “The real balance effect provides a possible dynamic explanation of the adjustments in the economy in going from one equilibrium to another and is an effective answer to the assertion of a Keynesian under-full-employment equilibrium. However, it is not really necessary for the
Keynes argued that an economy could be in equilibrium with a substantial amount of involuntary unemployment, but other economists disagreed and argued that a state in which an important market does not clear is one of disequilibrium. Explain the notions of equilibrium and disequilibrium involved,
What were Keynes’s arguments in his attacks on Say’s law and the traditional classical dichotomy? In retrospect, and especially in the light of the reversion (counterreformation!)of macroeconomics to the (modern version of the) classical model, evaluate the success of these attacks.
Does the dichotomy between the real and the monetary sectors hold in the modern classical approach? Is this dichotomy valid or not for the modern financially developed economy?
What was the dichotomy between the real and the monetary sectors in the traditional classical approach to macroeconomics? How would such a dichotomy arise in a Walrasian general equilibrium system?What was the contribution of Patinkin’s real balance effect to this debate?
For the magnitudes of the relevant variables in any of the past five years in your economy, try to assess the importance of the real balance effect for a 5 percent fall in the price level.
In terms of your understanding and beliefs about the functioning of your economy, which of the four markets (commodities, money, bonds and labor) clear on a daily, weekly and monthly basis? Which may not do so, at least within thirty days of a disturbance? Within 6 months? Within a year?If some of
Outline your understanding of households’ and firms’ most likely responses to a fall in the aggregate demand for commodities. Does its perceived duration matter? If a downturn in the economy leads to a fall in demand that is perceived to be significant in magnitude and duration, discuss whether
Derive the implications of Walras’s law and Say’s law together for the determinacy of absolute and relative prices in a commodities–money (no bonds or labor) economy.What role does the real balance effect (in the short run and the long run) play in this determination?
Do the modern classical or/and new classical schools effectively reinstate Say’s law as one of their component doctrines? Is so, should they state it explicitly? Discuss.
What are the implications for monetary policy if both Walras’s law and Say’s law are imposed on the IS–LM model? Assess the likely validity of these implications. If they do not seem to be valid, which of these two laws should be discarded? Derive the implications for monetary policy of
Walras’s law is derived from the budget constraints of all the economic agents in the economy. Can Say’s law be similarly derived from budget constraints? Use the relevant constraints and specify the additional assumptions needed for this derivation. Assess the validity of these assumptions.
Given the generally poor performance of the forward-looking forms of the Taylor rule and the Phillips curve implied by theNKmodel, especially relative to their backward-looking simpler versions, discuss whether the new Keynesian reformulation of Keynesianism has proved to be a failure. If this is
Write the general dynamic form of the sticky-price new Keynesian Phillips curve as:πt = βEtπt+1 +α(ut −un)+vt where π is the inflation rate, u is the unemployment rate, un is the natural rate, vt =ρvt−1 +ηt and η is a random variable with a zero mean and constant variance. Mankiw(2001)
Specify the three types (backward-looking, contemporaneous and forward-looking) of the Taylor rule on interest rates, and discuss their validity. Why does the forward-looking form implied by the new Keynesian model seem to do badly relative to the others, and especially relative to the
Suppose the price level in question 14 is fixed at P (making the model a fixed price one, compared with the preceding flexible price model). Re-do the answers to this question.
Suppose the supply function in the model of this question 14 is changed to:yt = yf +γ (Pt −Et−1Pt ) γ >0 Re-do the answers to question 14.
Suppose the output supply in the model of question 14 is not the full-employment level but is determined by demand. Re-do the answers to question 14.
Suppose the economy is described by:Aggregate supply:yt = yf Aggregate demand and fiscal policy:yt = α0 +α1(Mt −Pt )+α2Et−1(Pt+1 −Pt )+α3zt +μt α1,α2,α3 > 0 zt = γ0 +γ1zt−1 +ηt Money supply:Mt =M0 +νt where all variables are in logs. μ, η and ν are random disturbance terms.
Consider the following model:Aggregate supply:yt = γ (Pt −Et−1Pt )+γ (Pt −Et−2Pt )Aggregate demand:yt =Mt −Pt +μtμt = μt−1 +ηt where y, P and M have the usual meanings and are in logs. η is a serially uncorrelated error with mean zero and variance σ2.(i) How would you justify
Consider an economy with the following structure:Aggregate demand:yt =Mt −Pt +μt (A quantity theory type equation)Aggregate supply:yt = yf t +γ (Pt −Pe t )+ηt where the symbols have the usual meanings and are in logs. μ and η are random errors.Expectations are formed in one of the
Modern classical macroeconomics argues that anticipated monetary policy does not have real effects. The new classical macroeconomics argues that anticipated fiscal policy also does not have real effects. Adapt the Lucas–Sargent–Wallace model to explicitly incorporate both of these propositions.
“In the past forty years, macroeconomic theory has come full circle. The Keynesian views of the economy were discarded in the mid-1970s by the resurgent classical theory, but the latter, in turn, has been eroded to the point that the dominant theory is again a form of the Keynesian one.”
“Between 1930 and 1990, macroeconomic theory went through a full circle. The classical view of the 1920s was discarded in the 1930s and 1940s by Keynesian theory, but the latter, in turn, was gradually eroded to the point that the dominant theory by the 1980s had again become a form of the
Outline the development and current theoretical status of the tradeoff between the unemployment rate and the rate of inflation.
Why do models with rational expectations have difficulty in explaining the persistence of output from its trend and unemployment from the natural rate? What are some of the reasons given for this persistence? If this persistence were incorporated in them, what would be their implications for the
Present a model with rational expectations and the new Keynesian supply function. If policy makers and the public have the same information, can stabilization policies in a stochastic context affect aggregate demand and output (i) in the short run, (ii) in the long run?
Present a model with rational expectations and the Friedman–Lucas supply function.If policy makers and the public have the same information, can stabilization policies in a stochastic context change aggregate demand and output (i) in the short run, (ii) in the long run?
Inflation and unemployment are two crucial economic items of interest to the public.Is it possible to explain one without the other? Present at least one theory that explains each independently of the other and one theory that establishes their interdependence.Is there a genuine difference between
Discuss the evolution of the 1970s Monetarists’ claim that “only monetary policy is effective” to the doctrines of the modern classical school that “no foreseen monetary policy is effective” and “no systematic monetary policy is effective.” Would Friedman have subscribed to any of
Specify the hypotheses on the natural rate of unemployment and the rational expectations.Discuss the logical and historical relationship between them.Discuss, for each concept, whether disequilibrium in the economy is consistent with it or not. If it is, discuss the role and usefulness of monetary
What evidence would you need to establish whether or not money supply changes have been the main cause of changes in nominal income? What procedure can you use to determine the direction of causality between the changes in money and in income?
Discuss the significance of the credit channel in changing aggregate demand and output. What limitations, if any, on this significance are imposed by the addition of the expectations-augmented Phillips equation? What limitations, if any, on this significance are imposed by the addition of short-run
Discuss why the credit channel is likely to be more important in financially developing economies than in developed ones, and discuss its implications for the choice between the money supply and the interest rate as the appropriate monetary policy instrument.
Given your model of aggregate demand with three financial assets (money, bonds and credit) and the indirect production function with working capital and the new Keynesian Phillips curve, what are the effects of a contractionary monetary policy on output and employment in the short-run? What are its
Given your model of aggregate demand with three financial assets (money, bonds and credit) and the indirect production function with working capital (but without the new Keynesian Phillips curve), how can monetary policy produce an increase in short-run output and employment? Can it do so in
What is working capital? Justify its inclusion in a production function and show the impact of a decrease in working capital on the supply of short-run output and employment.
Given your model of aggregate demand when there are three financial assets, money, bonds and credit, show how the new Keynesian model allows shifts in the credit market to alter output and employment.
Given your model of aggregate demand when there are three financial assets, money, bonds and credit, and the standard classical production function, would disturbances in the loan market cause changes in output and employment? Your answer should present the determination of output and employment in
Specify a model of aggregate demand with three financial assets, money, bonds and credit.
Discuss the sources of imperfections in credit markets and their role in quantity and interest rate rationing.
Discuss the main characteristics of money, bonds, credit and equities/stocks in actual financial markets. What is gained and what is lost by having a macroeconomic model with only two financial assets, money and bonds, with the latter including credit and equities?
“It is now well established that a contractionary monetary shock increases unemployment before reducing inflation and that the peak impact on unemployment precedes the peak impact on inflation.” Discuss how well these observations are explained by (i) the modern classical model, (b) the new
“Because monetary shocks have a delayed and gradual impact on inflation, in essence we experience a credible announced disinflation every time we get a contractionary shock.Yet we don’t get the boom that the (new Keynesian) model says should accompany it.This means that something is
“Every major inflation has been produced by monetary expansion” (Friedman, 1968).Does this assertion hold for the NK model, whose equations do not even include a monetary aggregate as a variable?
How does the new Keynesian model differ from the earlier Keynesian deficient-demand model? How does it differ from the modern classical one? Which of the three models would explain involuntary unemployment in a recession following a fall in aggregate demand?
In the last two decades of the twentieth century, many economists believed that Keynesian economics give little or even wrong prescriptions for dealing with the current economic problems in the United States (or British or Canadian) economy. What justifies such comments? What are your views on this
“Keynesianism and new Keynesianism are fundamentally inconsistent in so far as their wage hypotheses are concerned. Keynesianism asserts nominal wage rigidity, at least downwards, while the new Keynesianism does not allow either nominal or real wage rigidity.” Discuss.
Keynes (1936) argued that, from a policy perspective, everything that can be achieved by a nominal wage cut can be more effectively achieved through an appropriate monetary policy.(a) Does this statement hold in the deficient-demand Keynesian model for a negative shock to (i) aggregate demand and
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