Monetary Policy: End $of$ Chapter Problem

$We$ discussed how hard $itisto$ keep $AD$ stable $or$ put $it$ back "where $it$ belongs" after a shock. Sometimes $itis$ better taking two years $to$ slowly and carefully undo $anAD$ shock rather than shift $it$ back quickly $in$ one year. $To$ illustrate, let's see how things turn out $if$ you take two years rather than one year $to$ react $to$ a negative velocity shock.

$In$ this question, your ultimate goal $isto$ get $AD$ back $to\frac{?}{(5\frac{?}{?}\%\frac{?}{?})}$ per year. The potential growth rate $is\frac{?}{(3\frac{?}{?}\%\frac{?}{?})}$ and expected inflation $is$ always $\frac{?}{(2\frac{?}{?}\%\frac{?}{?})}$ per year. Starting point:

$AD$: $\frac{?}{(1\frac{?}{?}\%)}=\frac{?}{?}$ Inflation $+$ Real Growth Rate

SRAS: Inflation $\frac{?}{()}=\frac{?}{?}$ Expected Inflation $\frac{?}{(+(\frac{?}{?})\text{R}\text{e}\text{a}\text{l}\text{G}\text{r}\text{o}\text{w}\text{t}\text{h}\text{R}\text{a}\text{t}\text{e}-\text{P}\text{o}\text{t}\text{e}\text{n}\text{t}\text{i}\text{a}\text{l}\text{G}\text{r}\text{o}\text{w}\text{t}\text{h}\text{R}\text{a}\text{t}\text{e}\frac{?}{()}\frac{?}{?})}$

$a.$ Slow approach: Add $\frac{?}{(2\frac{?}{?}\%\frac{?}{?})}$ per year $toAD$ for two years

$(through$ some mix $of$ money growth and higher confidence$).$

What will real growth equal each year?

Real growth rate $at$ the start:$\frac{?}{\%}$

Real growth rate $at$ the end $of$ year one:$\frac{?}{\%}$

Real growth rate $at$ the end $of$ year two:$\frac{?}{\%}$

IVionetary Policy: End $of$ Cnapter Probiem

Milton Friedman and Anna Schwartz argued $in$ their Monetary History $of$ the United States that money growth and velocity

usually shift $in$ the same direction. Thus, higher growth causes optimism and slower growth causes pessimism. They believed

that velocity had its own shocks $as$ well.

$a.$ Let's run through some examples $of$ how this might work,

$in$ a setting where the Fed wants $to$ keep $AD$ growth stable $at$

$10\%.To$ keep things simple, $we$ will assume that the Fed can

control money growth perfectly. $We$ will also assume that $a$

$1\%$ change $in$ money growth causes $a0\mathrm{.}5\%$ shock $to$ velocity

growth $in$ the same direction. Using these assumptions, fill $in$

the missing values for the following table. For each case:

$AD=$ Initial Velocity Shock $+$ Money Growth

$+$ Velocity Shock Caused $by$ Money Growth

Round your answer $to$ the nearest hundredth.

Year $2$ money growth:

$\%$ Year $2$ velocity shock:

$\%$