Suppose the money demand of individuals and firms depends on what they perceive to be the probabilities that the economy will expand or contract over the following six months. Suppose their money demand is given by the equation L = 0.5Y - 100i + 20z, where z is the probability that the economy is expanding six months in the future. If z = 1, the economy will certainly be in recovery, if z = 0, the economy will certainly be in recession, and for z between 0 and 1 there is some uncertainty about the future state of the economy. Use a classical (RBC) model of the economy. If the Fed moves the money supply to target the price level, how does the money supply relate to the expected future state of the economy? Is this an example of reverse causation?
What will be an ideal response?
For a given level of real output and the nominal interest rate, to target the price level means that the nominal money supply moves directly with z (so that ?M = 20?z). This a version of reverse causation because the probability of higher future output affects the money supply today.
You might also like to view...
Starting from long-run equilibrium, a decrease in autonomous investment results in ________ output in the short run and ________ output in the long run.
A. lower; potential B. higher; higher C. higher; potential D. lower; higher
Which of the following is not a precondition for price discrimination?
A. The seller must be able to distinguish buyers with different elasticities of demand. B. The good or service cannot be profitably resold by the original buyers. C. The commodity involved must be a durable good. D. The seller must possess some degree of monopoly power.
One school of thought that emphasizes the role that taxes play in an economy's supply of output is known as
A) classical economics. B) tax-and-spend economics. C) demand-pull economics. D) supply-side economics.
One of the opportunity costs of economic growth is
A) capital accumulation. B) technological change. C) reduced current consumption. D) the gain in future consumption.