Problem 1: Within the loanable funds theory, graphically show the effect of an increase in the money supply, assumed to be determined solely by the Fed, on the supply and demand for loanable funds and the equilibrium rate of interest assuming a constant real rate of interest and expected inflation to be constant.
Problem 2: Illustrate and discuss how an autonomous increase in the expected rate of inflation will change the equilibrium nominal interest rate. Consider an initial real rate of interest of 3 percent and an expected inflation rate of 2 percent. If the expected rate of inflation rises to 4 percent with the real interest rate constant, what would the resulting nominal interest rate become, using the Fisher relationship? The rise in the expected rate of inflation is considered to remain at the higher level. Define your terms and discuss a recommended monetary policy to achieve economic stabilization with price stability and an improvement in the balance of payments.
Problem 3: Starting from an equilibrium position as in 7.a, discuss the effects of the conduct of a more restrictive monetary policy if the markets believe that a Fed tightening will lower future (next period) inflation. How might a recession occur under this scenario?