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Page 338 1a. With high unemployment and falling inflation the economy faces a recessionary gap. Therefore, an expansionary monetary policy should be used. b. With an expansionary monetary policy, the Bank of Canada purchases government bonds in order to raise banks’ excess reserves. This results in a magnified rise in the money supply, thanks to the working of the money multiplier. The increase in the money supply causes the equilibrium nominal interest rate to fall, which raises investment by businesses and consumption spending on durables by households. The spending increase pushes up aggregate demand and raises both equilibrium output and the price level. As the economy expands, the recessionary gap shrinks and the unemployment rate falls. c. 2a. The nominal rate of interest on the treasury bill is 2.04 percent [= (($1 000 000 - $980 000)/$980 000) x 100], which is found by dividing the increase in the bill’s value during the year by the initial purchase price, with this ratio then multiplied 100 to turn it into a percentage. b. To raise the nominal interest rate on one-year treasury bills to 3 percent, the Bank must increase the supply of these bills in its auction. The result will be a drop in the purchase price of these bills, pushing up their nominal interest rate. Page 342 1a. The bond seller’s deposit increases by $10 000. b. The bank’s desired reserves rise by $500 [= ($10 000 x .05)]. c. The bank’s excess reserves increase by $9500 [= ($10 000 - $500)]. d. The maximum increase in the money supply is $200 000, which is found by adding the initial $10 000 rise in the money supply due to the expansion in the bond seller’s bank deposit and the maximum $190 000 [= $9500 x (1/.05)] increase in the money supply due to the rise in excess reserves multiplied by the money multiplier. 2a. The bond buyer’s deposit decreases by $2000. b. The bank’s desired reserves fall by $200 [= ($2000 x .10)]. c. The bank’s excess reserves decrease by $1800 [= ($2000 - $200)]. d. The maximum decrease in the money supply is $20 000, which is found by adding the initial $2000 fall in the money supply due to the reduction in the bond buyer’s bank deposit and the maximum $18 000 [= $1800 x (1/.10)] decrease in the money supply due to the fall in excess reserves multiplied by the money multiplier. Page 347 1a. A bout of cost-push inflation causes an outward shift in the Phillips curve, since this type of inflation is associated with a rise in the unemployment rate. This is the type of inflation that is not directly incorporated into the Phillips curve. b. A bout of demand-pull inflation moves the economy up and to the left along the economy’s stationary Phillips curve. This is the type of inflation that is directly incorporated into the Phillips curve. c. A contractionary monetary policy moves the economy down and to the right along the economy’s stationary Phillips curve, since such a policy reduces inflation and increases the rate of unemployment. 2a. With an initial equilibrium to the right of the long-run AS curve, real output exceeds its potential level, and the unemployment rate is below its natural rate. In the long run, the low unemployment rate will put upward pressure on wages, shifting the economy’s AS curve to the left. This gradual shift moves equilibrium leftwards towards the vertical long-run aggregate supply curve. b. If initial equilibrium is to the left of the long-run AS curve, then real output is below its potential level, and the unemployment rate exceeds its natural rate. In the long run, the high unemployment rate will put downward pressure on wages. This shifts the economy’s AS curve to the right, which gradually moves equilibrium rightwards towards the vertical long-run aggregate supply curve. |