Midterm 1

Question 1

Fed’s preferred inflation measure method

Answer 1

PCE deflator

Question 2

Gresham’s Law

Answer 2

If two forms of money are both legal tender, at a mint ratio that differs from the price ratio on the world market, the overvalued money will tend to drive the undervalued money out of circulation.

Question 3

Money demand & relations to y,i, other factors

Answer 3

m^D = M^S/P*

Change in income y0 →y1, shift the m^D curve

Change in interest rate i0→i1, move along the m^D curve

m^D (up) if Volume of real transactions (up) or avg time held between transactions (up)

Question 4

ABT Model

Answer 4

M^D = sqrt(BY/2i)

b=B/P

y = Y/P

m^D=sqrt(by/2i) (in real terms)

B= brokerage fees

m^D increases with sqrt of y, decreases with sqrt of i

Question 5

Quantity Theory of Money

Answer 5

yt=Yt * P0/Pt=real income in year t0

Yt = Nominal income

P0=base year price level

Qtom: P=Ms/mD,
P->P in LR

Real money demand mD is determined by vol of real transactions conducted with M, and avg length of time M is held between receipt and expenditure. Both are positively related to mD

Question 6

Walras’s Law

Answer 6

Aggregate Demand = Aggregate Supply

Aggregate Demand = D goods +m^D

Aggregate Supply = S good + m^S

D good + m^D = S good + m^S = Sgood + (M^s)/P

(M^s)/P - m^D = D good - S good

XS S of M = XS D for Goods

Question 7

Relationship between PV and i

Answer 7

PV=FV/(1+i)^m

i=(FV/PV)^(1/m)-1

Question 8

Bonds

Answer 8

PV=FV/(1+i)^m

PV=present value.
FV=future value.
i=nominal interest rate.
m =maturity.

Rise in bond yields=bond prices fall=longer maturity

ΔPV/PV ≈ -Δi * D

Question 9

Consols

Answer 9

also known as perpetuities

PVc=C/i

Dc=1/i

Question 10

Maturity and duration

Answer 10

For bond w/o coupon payment: ΔPV/PV ≈ -Δi * m

For bond w/ coupon payment: ΔPV/PV ≈ -Δi * D

Maturity and duration can serve to understand the sensitivity of bond price change to the change in interest rate

Duration coupon bond > duration amortized loan

Question 11

GDP Calculation

Answer 11

Real gdp 2030 = gross gdp 2030 * (P level 2020/P level 2030)

Question 12

CPI-U vs. PCE Deflator

Answer 12

CPI U 0.4% than pce deflator since 1983

PCE Deflator is closer to what CPI-U
measures than is GDP Deflator

Question 13

Most different from PCE Deflator

Answer 13

PPI

Question 14

Fisher Equation

Answer 14

i = r + π^e

Given r and π^e, we calculate nominal i by Fisher equation

Breakeven inflation rate π^e = i - r

Question 15

Core CPI U and PCE Deflator excludes:

Answer 15

food and energy

Question 16

TIPS

Answer 16

Provide direct observation of real rate r (indexed to CPI-U)

Treasury inflation-protected securities

Question 17

Adaptive Learning

Answer 17

Inferred real rate r

Estimated π^e using adaptive learning (Recursive least squares, weighted avg of past inflation)

Inferred real rate r = i - π^e

Inferred real rate becomes similar to TIPS breakeven rate 2003-21

Question 18

3 transfers from inflation

Answer 18

debt creditor redistribution

ripple effect

inflationary finance

Question 19

debt creditor redistribution

Answer 19

Nominal Debt paying i = r + π^e

No transfer when π^e=π

Creditor hurt when π > π^e, purchasing power creditor–> debtor

Debtor hurt when π < π^e, purchasing power debtor–> creditor

Question 20

Inflationary finance

Answer 20

Nominal Seigniorage: S = ΔM=change in money balance

s=ΔM/P = ΔM/M * M/P = μ*m
μ=money growth rate
m= real money balance

Inflation acts as a tax on m =M/P

Owners of m lose π*m

Govt. gains μ*m

purchasing power –>govt.

Question 21

Ripple effect

Answer 21

Purchasing power: price (up) LAST → price (up) FIRST

Transfer purchasing power from those who sell goods and services whose prices go up last to those who sell goods and services whose prices go up first

Question 22

Income velocity

Answer 22

V=Y/M = nominal income/nominal money balance

=inverse of avg time each $ is held

Why does V change: i = opportunity cost of holding M
i (up) → m^D (down), V (up)
m^D =m

Velocity rose 1950-1980. Fell 1985-present

Question 23

Dynamic form of Quantity Equation

Answer 23

μ + ΔV/V ≈ π + g

g=real income growth

Question 24

Self generating inflation

Answer 24

positive money supply shock results in μ (up)

→π(up) through π = μ + ΔV/V - g
→π^e (up) through adaptive learning
→i (up) through fisher equation
→m^D (down) through m^D=sqrt(by/2i)
→V (up) through V=y divided by m
→ΔV/V > 0 b/c V (up)
π(UP)

Question 25

Tilt effect

Answer 25

High inflation reduces affordability of homes

Question 26

self generating inflation cycle

Answer 26

P(up) ––> π^e (up) ––> i(up) ––> m^d (down), V (up) ––> P(up), etc.

But P is stable when π^e responds slowly to π. And when m^D responds weakly to i, π^e. Interrupting transition to expected inflation up, and to m^D (down), V(up), respectively.

Question 27

Target Seigniorage and LR Monetary Laffer Curve

Answer 27

s = ΔM/P = ΔM/M * M/P = μ*m

m = m^D (i), i=r +μ + ΔV/V - g ≈ μ

→m^D (μ), μ = π^e -ΔV/V +g ≈ π^e

→m =m^D(μ) = m^D (π^e)

→s = μ * m^D

s* less than s max: unique and steady inf on LR laffer curve

s* more than s max: then unbounded runaway inf

Question 28

Inflation induced taxation of capital equation

Answer 28

r AT = r(1-τ)-π τ

Question 29

Bracket creep

Answer 29

inflation results in same real income taxed by a higher rate; income taxes increases proportional to nominal income. So since 1981, Fed brackets indexed to CPI-U (indexed for inflation rate) since 1981

Question 30

Loanable funds model of r

Answer 30

Credit Market equilibrium (non monetary economy)

A decrease in savings behavior by household will tend to shift the supply of credit to the left and increase real interest rates.

An increase in borrowing behavior by households will tend to shift the demand for credit to the right and increase real interest rates

(1+r)^m is price of present goods in terms of future goods: 1 present good costs (1+r)^m future goods (on average)

r ­(up) → present goods more costly (rel. to future goods)
r (down) → present goods less costly
r=real interest rates

Question 31

3 motives for μ, π

Answer 31

inflationary finance.
stimulate y, reduce U.
Reduce i, r

Question 32

Yield to maturity..

Answer 32

PV=F (face value), bond is at par, YTM=C/F

PV less than F: bond is below par, YTM greater than C/F

PV>F, bond is above par, YTM less than C/F

Question 33

Maturity and duration properties..

Answer 33

D=m if C =0 or m=1

D less than m if C more than 0 and m>1

D increases with m

D decreases with C/F

Question 34

Price floor..

Answer 34

Pmin > P eq

Q^S > Q^D

Question 34

Price ceiling..

Answer 34

Pmax<p></p>