Columbia College. Economics 3213

  Professor Xavier Presents

Problem Set 9

(1) Beast

(a) Explain how monetary policy can affect the interest rate in the Keynesian model.

(b) Using a graph, analyze the short-run, medium-run, and long-run implications on output, interest rates and the price level of an expansionary monetary policy (an increase in money supply).

(c) Are the results in (b) different to the results you would get in the classical model? What are the key differences in the assumptions?

(2) Lumi�re

In class, we argued that the Keynesian model assumes that output is demand determined. Notice that, when r<r*, demand is larger than supply so the assumption of output being determined by demand means that we can somehow force firms to produce more than they want to. Let's see whether the Keynesian conclusions hold under two different scenarios.

We still assume that (1) Prices were sticky, (2) Money market always clear. Now, instead of assuming that output is demand determined we use the assumption that OUTPUT IS ALWAYS SUPPLY DETERMINED (in other words, if Y^d is different from Y^s, then Y=Y^s.)

(i) Under this new set up, starting from a classical equilibrium, what is the effect on the interest rate and on output of a DECREASE in money supply?

(ii) What is the effect of an INCREASE in money supply?

(iii) Is money neutral in this case? Does money affect output in the "right" direction? Discuss.

(3) Gaston     

The set up in (3) has the problem that, when r>r*, then supply is larger than demand.  Hence, if we assume that output is supply determined, we get that we are "forcing" consumers and firms to somehow buy more than they want to. Some people might think that this is unreasonable. Hence, let us assume now that if Y^d is different from Y^s, then Y is determined by the short-side of the market (so, for r<r*, supply  wins and for r>r*, demand wins).

(i) Under this new set up, starting from a classical equilibrum, what is the effect on the interest rate and on output of a DECREASE in money supply?

(ii) What is the effect of an INCREASE in money supply?

(iii) Is money neutral in this case? Does money affect output in the "right" direction (for both an increase in M^s and a decrease in M^s? Is your answer different from (2)? Discuss.