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Macroeconomics 3rd Canadian Edition Paul Krugman, Robin Wells, Iris Au, Jack Parkinson - Solutions

8. Using a graph like Figure 17-3, show how a monetarist can argue that a contractionary fiscal policy need not lead to a fall in real GDP given a fixed money supply. Explain.
7. Which of the following policy recommendations are consistent with the classical, Keynesian, monetarist, and/or Great Moderation consensus, and, expansionary austerity, and secular stagnationist views of the macroeconomy?a. Since the long-run growth of GDP is 2%, the money supply should grow at
6. The economy of Albernia is facing a recessionary gap, and the leader of that nation calls together its best economists representing the classical, Keynesian, monetarist, real business cycle, Great Moderation consensus, expansionary austerity, and secular stagnationist views of the macroeconomy.
5. The chapter notes that Kenneth Rogoff proclaimed U.S. President Richard Nixon “the all-time hero of political business cycles.” Using the following table of data from the Economic Report of the President, explain why Nixon may have earned that title. (Note: Nixon entered office in January
4. In the modern world, central banks are free to increase or reduce the money supply as they see fit. However, some people harken back to the “good old days” of the gold standard. Under the gold standard, the money supply could expand only when the amount of available gold increased.a. Under
3. The fall of its military rival, the Soviet Union, in 1989 allowed the United States to significantly reduce its defense spending in subsequent years. Using the data in the following table from the Economic Report of the President, replicate Figure 17-2 for the 1990–2000 period. Given the
2. The C.D. Howe Institute Business Cycle Council is an arbiter of the chronology of Canadian business cycles. Go to its website at https://www.cdhowe.org/council/business-cycle-councila. How many business cycles have occurred since the end of World War II in 1945?b. What was the average duration
1. Since the crash of its stock market in 1989, the Japanese economy has seen little economic growth and some deflation. The accompanying table from the Organization for Economic Cooperation and Development (OECD) shows some key macroeconomic data for Japan for 1991 (a “normal” year) and
11. Concerns over crowding out and time lags were irrelevant given the length and severity of the Great Recession in Canada and the United States. Active fiscal policy was revived given the ineffectiveness of monetary policy in the liquiditytrap environment. Most economists returned to a Keynesian
10. In Europe, the theory of expansionary austerity became popular. Believing that what ailed the economy was a lack of private-sector confidence due to concern that government debts would not be repaid, policy makers cut government spending. The theory was dealt a significant blow when countries
9. Adherents of the inflation bear viewpoint opposed the U.S. Federal Reserve Bank unconventional monetary policy, arguing that it would harm the economy by sparking inflation without raising output. They are aligned with the classical and new classical viewpoints because of their belief that
8. Secular stagnationists believed that declining population growth and a slowdown in technological factors led to a state of persistent economic weakness, and that full employment could only be reached by pushing the interest rate consistently below zero. They advocated expansionary fiscal policy
7. The Great Moderation from 1992 to 2007 generated the Great Moderation consensus: belief in monetary policy as the main tool of stabilization; skepticism toward use of fiscal policy, except possibly in exceptional circumstances such as a liquidity trap; and acknowledgment of the policy
6. New Keynesian economics argues that market imperfections can lead to price stickiness, so that changes in aggregate demand have effects on aggregate output after all.
5. Rational expectations claims that individuals and firms make decisions using all available information. According to the rational expectations model of the economy, only unexpected changes in monetary policy affect aggregate output and employment; expected changes merely alter the price level.
4. The natural rate hypothesis became almost universally accepted, limiting the role of macroeconomic policy to stabilizing the economy rather than seeking a permanently lower unemployment rate. Fears of a political business cycle led to a consensus that monetary policy should be insulated from
Why was the Great Moderation consensus undermined by the 2008 financial crisis, leading to fierce debates among economists and the emergence of two post–Great Recession policy camps?s stable—that GDP would grow steadily if the money supply grew steadily, was influential for a time but was
How did challenges lead to a revision of Keynesian economics and the emergence of the new classical macroeconomics?
What is monetarism and why did monetarists claim there are limits to the use of discretionary monetary policy?
How did John Maynard Keynes and the experience of the Great Depression legitimize macroeconomic policy activism?
Why was classical macroeconomics inadequate for the problems posed by the Great Depression?
13. Due to historical differences, countries often differ in how quickly a change in actual inflation is incorporated into a change in expected inflation. In a country such as Japan, which has had very little inflation in recent memory, it will take longer for a change in the actual inflation rate
12. Who are the winners and losers when a mortgage company lends $100,000 to the Miller family to buy a house worth $105,000 and during the first year prices unexpectedly fall by 10%? What would you expect to happen if the deflation continued over the next few years? How would continuing deflation
11. The economy of Brittania has been suffering from high inflation with an unemployment rate equal to its natural rate. Policy makers would like to disinflate the economy with the lowest economic cost possible. Assume that the state of the economy is not the result of a negative supply shock. How
10. The accompanying table provides data from Canada on the average annual rates of unemployment and inflation rate. Use the numbers to construct a scatter plot similar to Figure 16-5. Discuss why, in the short run, the unemployment rate rises when inflation falls. Year Unemployment rate Inflation
9.a. Go to http://www.statcan.gc.ca/eng/start. Scroll down the page to find the “Consumer Price Index” link on the left side of the page. What is the annual percentage change in the CPI for the most recent month available? Click on the link and scroll down the page and click on the link to open
8. After experiencing a recession for the past two years, the residents of Albernia were looking forward to a decrease in the unemployment rate. Yet after six months of strong positive economic growth, the unemployment rate has fallen only slightly below what it was at the end of the recession. How
7. The accompanying scatter diagram shows the relationship between the unemployment rate and the output gap in Canada from 1996 to 2016. Draw a straight line through the scatter of dots in the figure. Assume that this line represents Okun’s law: Unemployment rate = b – (m × Output gap) where b
6. Concerned about the crowding-out effects of government borrowing on private investment spending, a candidate for prime minister argues that Canada should just print money to cover the government’s budget deficit. What are the advantages and disadvantages of such a plan?
5. The inflation tax is often used as a significant source of revenue in developing countries where the tax collection and reporting system is not well developed and tax evasion may be high.a. Use the numbers in the accompanying table to calculate the inflation tax in Canada and India (Rp =
4. Answer the following questions about the (real) inflation tax, assuming that the price level starts at 1.a. Maria Moneybags keeps $1,000 in her sock drawer for a year. Over the year, the inflation rate is 10%. What is the real inflation tax paid by Maria for this year?b. Maria continues to keep
3. Access the Discovering Data exercise for Chapter 16 online to answer the following questions.a. How much did the monetary base change in the last year?b. How did the change in the monetary base help in the government’s efforts to finance its deficit?c. Why is it important for the central bank
2. In the following examples, would the classical model of the price level be a useful model for analyzing how the economy behaves?a. The economy has high unemployment and no history of inflation.b. The economy has just experienced five years of hyperinflation.c. Although the economy experienced
1. In the economy of Scottopia, policy makers want to lower the unemployment rate and raise real GDP by using monetary policy. Using the accompanying diagram, show why this policy will ultimately result in a higher aggregate price level but no change in real GDP. All three lines intersect at
7. Deflation poses several problems. It can lead to debt deflation, in which a rising real burden of outstanding debt intensifies an economic downturn. Also, nominal interest rates are more likely to run up against the zero lower bound in an economy experiencing deflation. When this happens, the
6. Once inflation has become embedded in expectations, getting inflation back down can be difficult because disinflation can be very costly, requiring the sacrifice of large amounts of aggregate output and imposing high levels of unemployment. However, policy makers in Canada, the United States,
5. At a given point in time, there is a downward-sloping relationship between unemployment and inflation known as the short-run Phillips curve. This curve is shifted by changes in the expected rate of inflation. The long-run Phillips curve, which shows the relationship between unemployment and
4. Countries that don’t need to print money to cover government deficits can still stumble into moderate inflation, either because of political opportunism or because of wishful thinking.
3. The output gap is the percentage difference between the actual level of real GDP and potential output. A positive output gap is associated with lower-than-normal unemployment; a negative output gap is associated with higher-than-normal unemployment. The relationship between the output gap and
2. Governments sometimes print money in order to finance budget deficits. When they do, they impose an inflation tax, generating tax revenue equal to the inflation rate times the money supply, on those who hold money. Revenue from the real inflation tax, the inflation rate times the real money
1. In analyzing high inflation, economists use the classical model of the price level, which says that changes in the money supply lead to proportional changes in the aggregate price level even in the short run.
Why is deflation a problem for economic policy makers?
Why can even moderate levels of inflation be hard to end?
Why does the trade-off between inflation and unemployment cease in the long run?
How does the Phillips curve describe the short-run trade-off between inflation and unemployment?
Why can printing money lead to high rates of inflation and hyperinflation?
13. Because of the economic slowdown associated with the 2008–2009 recession, the Governing Council of the Bank of Canada, between December 4, 2007 and April 21, 2009, lowered its target for the overnight interest rate in a series of steps from a high of 4.5% to a rate of 0.25%. The idea was to
12. During the Great Depression, businesspeople in Canada were very pessimistic about the future of economic growth and reluctant to increase investment spending even when interest rates fell. How did this limit the potential for monetary policy to help
11. The effectiveness of monetary policy depends on how easy it is for changes in the money supply to change interest rates. By changing interest rates, monetary policy affects investment spending and the aggregate demand curve. The economies of Albernia and Brittania have very different money
10. According to the European Central Bank website, the treaty establishing the European Community “makes clear that ensuring price stability is the most important contribution that monetary policy can make to achieve a favourable economic environment and a high level of employment.” If price
9. An economy is in long-run macroeconomic equilibrium with an unemployment rate of 5% when the government passes a law requiring the central bank to use monetary policy to lower the unemployment rate to 3% and keep it there. How could the central bank achieve this goal in the short run? What would
run?
8. Suppose that the money market in Westlandia is initially in equilibrium and the central bank decides to decrease the money supply.a. Using a diagram like the one in Problem 7, explain what will happen to the interest rate in the short run.b. What will happen to the interest rate in the long
7. In the economy of Eastlandia, the money market is initially in equilibrium when the economy begins to slide into a recession.a. Using the accompanying diagram, explain what will happen to the interest rate if the central bank of Eastlandia keeps the money supply constant at M¯1.b. If the
6. An economy is facing the inflationary gap shown in the accompanying diagram. To eliminate the gap, should the central bank use expansionary or contractionary monetary policy? How will the interest rate, investment spending, consumer spending, real GDP, and the aggregate price level change as
5. An economy is facing the recessionary gap shown in the accompanying diagram. To eliminate the gap, should the central bank use expansionary or contractionary monetary policy? How will the interest rate, investment spending, consumer spending, real GDP, and the aggregate price level change as
4. Go to www.bankofcanada.ca/rates/interest-rates/canadian-bonds/. Use the most recent data on the list of benchmark bond yields listed there to answer these questions.a. What are the interest rates on one- to three-year and 10-year Government of Canada bonds?b. How do the interest rates on the
3.a. Go to www.bankofcanada.ca/rates/interest-rates/t-bill-yields/. Find the part of this page that deals with average yields for recent six-month Government of Canada treasury bill auctions. What is the interest rate for the most recently issued six-month T-bills?b. Go to the website of your
2. How will the following events affect the demand for money? In each case, specify whether there is a shift of the demand curve or a movement along the demand curve and its direction.a. There is a fall in the interest rate from 12% to 10%.b. Cold weather arrives and with it, the beginning of the
1. Go to the schedule of key interest rate announcements page of the Bank of Canada’s website (www .bankofcanada.ca/core-functions/monetary-policy/key-interestrate/#schedule) to find the list of the BOC’s eight fixed-interest rate announcement dates for the current year. Now, to find the most
There is a zero lower bound for interest rates—they cannot fall much below zero without causing significant problems—that limits the power of monetary policy. Because it is subject to fewer lags than fiscal policy, monetary policy is the main tool for macroeconomic stabilization.
Many central banks set monetary policy by inflation targeting, a forward-looking policy rule. Although inflation targeting has the benefits of transparency and accountability, some think it is too restrictive.
The Bank of Canada and other central banks generally try to tame the business cycle while keeping the inflation rate low but positive.
The Bank of Canada can use expansionary monetary policy to increase aggregate demand and contractionary monetary policy to reduce aggregate demand.
In practice, the BOC sets a target for the overnight rate and uses open-market operations to achieve that target. Long-term interest rates reflect expectations about what’s going to happen to short-term rates in the future. Because of risk, long-term interest rates tend to be higher than
The Bank of Canada can move the interest rate through open-market operations that shift the money supply curve.
According to the liquidity preference model of the interest rate, the equilibrium interest rate is determined by the money demand curve and the money supply curve.
. Now assume that the Bank of Canada is following a policy of targeting the overnight rate. What will the BOC do in the situation described in Question 1 to keep the overnight rate unchanged? Illustrate with a diagram. 3. Malia must decide whether to buy a one-year bond today and another one a year
. Assume that there is an increase in the demand for money at every interest rate. Using a diagram, show what effect this will have on the equilibrium interest rate for a given money supply.
2. The quantity of interest-bearing money assets demanded is less than the quantity supplied.
1. The quantity of money demanded is more than the quantity of money supplied.
Changes in the aggregate price level, real GDP, credit markets and banking technology, and institutions shift the money demand curve. An increase in the demand for money shifts the money demand curve rightward; a decrease in the demand for money shifts the money demand curve leftward.
Holding money provides liquidity but incurs an opportunity cost that rises with the interest rate, leading to the downward slope of the money demand curve.
Money offers a lower rate of return than other financial assets. We usually compare the rate of return on money with short-term, not long-term, interest rates.
Why does the Bank of Canada pursue inflation targeting and how does it use monetary policy to achieve the inflation target?
Why economists believe in monetary neutrality—that monetary policy affects only the price level, not aggregate output, in the long run?
Why is monetary policy the main tool for stabilizing the economy?
How does the Bank of Canada implement monetary policy?
Why does the liquidity preference model determine the interest rate in the short run?
What is the money demand curve?
14. As Figure 14-13 shows, the portion of the Bank of Canada’s assets made up of Canadian government treasury bills and bonds declined in late 2008. Go to StatCan’s home page at www.statcan.gc.ca. Choose English or French. Scroll down the home page and click on “CANSIM”. Under “Search
13. In 2016, the Bank of Canada estimated that at least $894,000 of counterfeit Canadian banknotes were in circulation (down from about $6 million in 2008).a. Why do Canadian taxpayers lose because of these counterfeit notes?b. As of December 2016, the interest rate earned on one-year Canadian
12. Show the changes to the T-accounts for the Bank of Canada and for commercial banks when the Bank of Canada sells $30 million in treasury bills. If the public holds a fixed amount of currency (so that all new loans create an equal amount of chequable deposits in the banking system) and the
11. Macroland has a very simple banking system, in which there is only one chartered bank (The First Bank). The government of Macroland imposes a minimum required reserve ratio of 3%. Individuals in Macroland hold a fixed amount of $1200 in the form cash to facilitate their daily transactions and
10. Although the Bank of Canada does not impose a minimum reserve ratio on the banking sector, the central bank of Albernia does. The commercial banks of Albernia have $100 million in reserves and $1,000 million in chequable deposits; the initial required reserve ratio is 10%. The commercial banks
9. In Westlandia, the public holds 50% of M1+ in the form of currency, and the voluntary reserve ratio is 20%. Estimate how much the money supply will increase in response to a new cash deposit of $500 by completing the accompanying table. (Hint: The first row shows that the bank must hold $100 in
8. What will happen to the money supply under the following circumstances in a chequable-deposits-only system?a. The desired reserve ratio is 25%, and a depositor withdraws $700 from his chequable deposit.b. The desired reserve ratio is 5%, and a depositor withdraws $700 from his chequable
7. The government of Eastlandia uses measures of monetary aggregates similar to those used by Canada, and the commercial banks in Eastlandia hold a desired reserve ratio of 10%. Given the following information, answer the questions below. Bank deposits at the central bank = $200 million Currency
6. Ryan Cozzens withdraws $400 from his chequing account at the local bank and keeps it in his wallet.a. How will the withdrawal change the T-account of the local bank and the money supply?b. If the bank maintains a desired reserve ratio of 10%, how will it respond to the withdrawal? Assume that
5. Tracy Williams deposits $500 that was in her sock drawer into a chequing account at the local bank.a. How does the deposit initially change the T-account of the local bank? How does it change the money supply?b. If the bank maintains a desired reserve ratio of 10%, how will it respond to the new
4. Indicate whether each of the following is part of M1+, M2, M2+, or none of them:a. $95 on your campus meal cardb. $0.55 in the change cup of your carc. $1,663 in your savings account in a credit uniond. $459 in your chequing account in a chartered banke. 100 shares of stock worth $4,000f. A
3. The table that follows shows the components of M1+, M2, and M2+ in billions of dollars from January 2016 to March 2017 as published in the Bank of Canada’s Banking and Financial Statistics published in June 2017. Complete the table by calculating M1+, M2, M2+, currency in circulation as a
2. There are three types of money: commodity money, commodity-backed money, and fiat money. Which type of money is used in each of the following situations?a. Bottles of rum were used to pay for goods in colonial Australia.b. Salt was used in many European countries as a medium of exchange.c. For a
. For each of the following transactions, what is the initial effect (increase or decrease) on M1+? On M2? On M2+?a. You sell a few shares of stock and put the proceeds into your savings account in a chartered bank.b. You sell a few shares of stock and put the proceeds into your chequing account in
12. During the crisis of 2008 and subsequent recession, the Bank of Canada acted much like the Fed, the American central bank. It lowered its target rate for the overnight market, increased lending to Canadian financial institutions, and lengthened the list of securities it would accept as
11. The emergence of shadow banking, bank-like activities undertaken by nondepository financial firms which were not subject to regulatory oversight or protection, made the financial system once again vulnerable to bank-run type panics. In the mid-2000s, securitization of U.S. mortgage loans from
10. The Great Depression sparked widespread bank runs in the United States, which greatly worsened and prolonged it even further. In response, the American government created federal deposit insurance to reduce the risk of bank runs. Public acceptance of deposit insurance finally stopped the
9. To counteract a poor monetary policy that had worsened the effects of the Great Depression, the Bank of Canada was created. The BOC’s duties were to be the sole issuer of legal tender Canadian banknotes, centralize the holding of reserves, regulate and inspect banks’ books, and make the
8. The Bank of Canada’s principal tools of monetary policy are open-market operations and deposit switching. To increase the monetary base, the BOC can buy Canadian treasury bills from commercial banks or switch government deposits from itself to banks. To reduce the monetary base, the BOC can
7. The monetary base is controlled by the Bank of Canada (BOC), the central bank of Canada. The BOC regulates banks and helps to set overnight interest rates. To meet their desired reserve requirements, banks borrow and lend reserves in the overnight funds market usually at an interest rate very

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