Questions
1. Let's examine how the goals of the Fed influence its response to shocks. Suppose that in scenario A the Fed cares only about keeping the price level stable and in scenario B the Fed cares only about keeping output and employment at their natural levels. Explain how in each scenario the Fed would respond to the following.
a. An exogenous decrease in the velocity of money.
b. An exogenous increase in the price of oil.
2. An economy begins in the long-run equilibrium, and then a change in government regulations allows banks to start paying interest on checking accounts. Recall that the money stock is the sum of currency and demand deposits, including checking accounts, so this regulatory change makes holding money more attractive.
a. How does this change affect the demand for money?
b. What happens to the velocity of money?
c. If the Fed keeps the money supply constant, what will happen to output and prices in the short run and in the long run?
d. If the goal of the Fed is to stabilize the price level, should the Fed keep the money supply constant in response to this regulatory change? If not, what should it do? Why?
e. If the goal of the Fed is to stabilize output, how would your answer to part (d) change?
3. In the Solow model, what determines the steady-state rate of growth of income per worker?
4. In the steady state of the Solow model, at what rate does output per person grow? At what rate does capital per person grow? How does this compare with the US experience?
5. How can policymakers influence a nation's saving rate?