Columbia College. Economics 3213

Professor Xavier Presents...

Problem Set 7

POCAHONTAS

(1) Ratcliffe

(A) What are the costs of transacting between money and financial assets?

(B) What have been the effects of the introduction of ATM machines to aggregate money demand?

(C) How would you relate the introduction of ATM machines to the model of money demand discussed in class?

(2) Grandmother Willow

(A) Does Walras' Law say that the output market is inequilibrium all the time (note: the "output" market is what we call the "cookie" market in class)?

(B) Does Walras' Law say that all the markets are in equilibrium ALL THE TIME?

(C) What does Walras' Law say?

(D) Show how to derive Walras' Law by using the household budget constraint.

(E) Why do you think Walras' Law is a useful law?

(3) Meeko

(A) What happens in the classical model when the government prints money? Why is money neutral in the classical model?

(B) Milton Friedman said that "Inflation is, always and everywhere, a Monetary Phenomenon". Do you think this is true? Discuss.

(C) Some people think that, even though money may be a monetary phenomenon, behind the inflation problem, there is always a FISCAL problem (the government is forced to print money for fiscal reasons). Explain why.

(D) Most cases of hyperinflation in history (though not all) occurred in the XXth century. Why do you think this was the case?

(E) Ronald Reagan said: "Inflation is a tax. In fact, inflation is the cruelest of taxes because poor people tend to pay it". Why is inflation a tax? Who pays this tax? Do you think poor people pay a larger fraction of this tax? Explain.

(F) If expanding money supply has adverse consequences (that is, it generates inflation), why do you think governments all over the world keep increasing the money supply?

(4) Savages

(A) What is the effect of a TEMPORARY POSITIVE productivity shock on aggregate output, the interest rate and the price level?

(B) What is the effect of a PERMANENT POSITIVE productivity shock on aggregate output, the interest rate and the price level? Why is your answer different from (A)?

(5) Chief Powhatan

In 1973, oil prices jumped to previously unseen levels. This episode can be regarded as an adverse productivity shock.

(a) If people thought that this was a temporary shock, what would happen to output, the interest rate, and prices? Can this explain "stagflation" (stagflation is a situation of deep recession -stagnation- coinciding with increases of prices -inflation)?

In 1979, there was another large and temporary increase in the price of oil. This time, however, Paul Volker headed the Fed and decided that he did not want the oil shock to cause any increase in the price level. Consequently, he changed the money supply with the intention of keeping the price level constant.

(b) How does your analysis change in part (a) when, at the time of an adverse shock, the money supply changes so as to leave the price level unchanged? How does M^s need to change in order to achieve price stability? (Increase or decrease?)

(c) Suppose that some economists did not hear about the oil shock, but noticed that money supply and output both fell at the same time. What may they conclude about the neutrality of money? When you observe money and output moving in the same direction, does it mean that money is NOT neutral?