Suppose the Demand for Real Balances is given by the following equation:
(m/p)d = 1500 + 0.2Y - 10,000( r + πe).
Assume M = 4,000, P = 2, πe = .01 and Y = 5,000.
a. What is the equilibrium real interest rate? (It will be in decimal form. P and Y are given)
b. Show you results on a properly labeled Md/Ms diagram and label the equilibrium as point A.
c. Suppose Janet Yellen and the Fed make statements and speeches to raise inflationary expectations to 4% (.04) and are successful. Solve for equilibrium real interest rate.
d. Show this equilibrium on your diagram and label as point B.
e. Why would the Fed want to do this?
f. Explain which economic variables