To answer the following question, please refer to the figure below. Concentrating only at the lower right quadrant, discuss the effects of a change in U.S. expected inflation
What will be an ideal response?
Lower right quadrant shows the equilibrium in the U.S. Money Market, where
= /
A given interest rate R1$ corresponds with a given U.S. real money supply, / .
Consider a rise of ΔΠ in the future rate of U.S. money supply growth (i.e. an increase in the expected rate of inflation).
The Key Point: The rise in expected future inflation generates expectations of more rapid currency depreciation in the future.
Under PPP the dollar now depreciates at a rate of Π + ΔΠ. Interest parity therefore requires the dollar interest rate to rise where
= + ΔΠ. (Point 2 in the figure.)
Note: R$ - = -
This relation shows a change in the U.S. interest rate due to an increase in expected U.S. inflation has no effect on the euro interest rate.
The rise in the interest rate from to creates a momentary excess supply of real U.S. money balances at the prevailing price level . However, since under this.
Monetary Approach, prices are assumed to be flexible, prices will immediately adjust from to , thus causing the following two effects: One, Reducing real money supply and two, bringing U.S. money market back into equilibrium.
You might also like to view...
The social interest theory of regulation asserts that regulation
A) seeks an efficient use of resources. B) is aimed at keeping prices as low as possible. C) helps firms maximize economic profit. D) of a natural monopoly must be done using rate of return regulation. E) does not work for society as well as would allowing the firms freedom from regulation.
Marginal cost is the ________ associated with a particular increase in an activity
A) additional cost B) opportunity cost C) forgone cost D) total cost
Refer to Figure 26-12. In the dynamic AD-AS model, the economy is at point A in year 1 and is expected to go to point B in year 2, and the Federal Reserve pursues policy. This will result in
A) real GDP levels higher than what would occur if no policy had been pursued. B) inflation rates higher than what would occur if no policy had been pursued. C) potential real GDP levels lower than what would occur if no policy had been pursued. D) unemployment rates higher than what would occur if no policy had been pursued.
An economy has two workers, Jen and Rich. Every day they work, Jen can produce 2 TVs or 10 radios, and Rich can produce 4 TVs or 12 radios. What is the opportunity cost for Jen to produce one TV?
A. 10 radios B. 1/5 radio C. 1/3 radio D. 5 radios