homework4.pdfhomework4.pdfhomework4.pdf1 Short Answer 1.1 True / False Are low nominal interest rates always a sign of tight money? 1.2 In the delevraging model in class, why must prices/interest rates fall when (binding) constraints on debtors get tighter ? 1.3 What do falling prices do to the value of debt in nominal terms? 1.4 What do countries give up when they choose to ﬁx an exchange rate. Why might a country do this? 2 Model Analysis Following the question label each part by the number it corresponds to. 2.1 Using the IS-MR-PC Model show the following: 1. Consumers and Investors begin to worry about lower gdp in the future, reducing consumer and investor sentiment. 2. Why does this put downward pressure on land prices? Further reducing wealth of households and ﬁrms. If land is used as collarteral, how is the initial shock ampliﬁed? Show the eﬀects of this change on the model. 1 3. Given this and decreased inﬂation expectations, why does the money sup- ply decrease? What eﬀect does the increase have on Y,r,i? Why might the Investment Savings equation change/shift? 4. What happens to zero lower bound as disinﬂation increases. Given that the stabilizing interest rate lies below the zero lower bound, what policy actions could be done to allow the few to operate according the monetary rule. 2.2 Use the partially open model, IS-LM/ IS-MR-PC for the central bank questions at the end. 1. The central bank ﬁxes the exchange rate in a partially open economy (assume like in class that marginal propensity to import is zero). Show a decrease in consumer demand 2. Neighboring countries also experience recessions so exporter sentiment falls. What eﬀect does this have on output? 3. Since Y falls, what happens to taxes. Is the debt to nominal gdp ratio growing overtime. 4. Show the eﬀect of the increase in r on the debt growth rate from risk premia. 5. How might this eﬀect LM curve? Why might ﬁscal austerity be expan- sionary? 6. Why might ﬁscal policy be ineﬀective? Why can’t the country use mone- tary policy while keeping the ﬁxed exchange rate? 7. What is the right policy response from the central bank? 8. Show what happens when the central bank implements the plan above.