Study Questions No. 8 (March 8, 2011) Economics 130 Winter 2011 These key terms and questions are designed to help you in your understanding of the material covered in class and in the textbook. Key terms: Equation of exchange; quantity theory of money; quantity theory of money demand; velocity of money; equation of exchange; real money balances; Keynes’s liquidity preference theory; Cash balances in Baumol-Tobin model; accommodating monetary policy; constant-money-growth rule; demand-pull inflation; cost-push inflation; monetizing the debt; government budget constraint; discretionary policy. Questions: 1. Using data available from the Federal Reserve Bank of St. Louis website, FRED data base, look up the M2 aggregate and calculate the velocity of money (v) for 2006-2010. What has happened to v? 2. If velocity and aggregate output remain constant at 5 and 1,000, respectively, what happens to the price level if the money supply declines from $400 billion to $300 billion? 3. What is Keyne’s (a) transactions motive for holding money? (b) precautionary motive? (c) speculative motive? 4. If interest rates on bonds go to zero, what does the Baumol-Tobin analysis suggest would happen to average holdings of money balances in the economy? (Show by way of a diagram). 5. What are the primary differences between the Quantity Theory of Money Demand and Keynes’s theory of money demand? 6. What happens to the velocity of money with an upward movement along a given LM curve? 7. What are the two approaches for deriving the economy’s Aggregate Demand Curve (AD)? Why is the AD curve downward sloping? 8. What happens to the AD curve when government expenditures rise? Taxes rise? The Fed expands the money supply? Consumer confidence declines? Business confidence rises? A collapses of the stock market? A banking crisis? 9. What is the short-run aggregate supply curve (AS) upward sloping? 10. What are the primary factors that cause a shift in the AD curve? 11. What is the “self adjustment” mechanism of the economy following a banking crisis in the economy? How long does the self-adjustment take? Why does the process depend on wage and price flexibility? 12. What is the characteristic real GDP and inflation pattern following a demand shock? What is this form of inflation called? 13. What is the characteristic real GDP and inflation pattern following a supply shock? What is this form of inflation called?14. Was the pattern of real GDP and inflation during the 2007-09 recession mainly consistent with a negative demand shock or a negative supply shock? 15. Which U.S. recessions have primarily been associated with negative oil shocks? 16. When aggregate output is below potential output of the economy, what will likely happen to the price level over time if the aggregate demand curve remains unchanged? Why? 17. Economic circumstances in the U.S.—monetary policy tightening is likely with the winding down of QE2, fiscal policies are tightening at the Federal-State-local levels, sharp oil prices increases. Predict GDP and inflation using AD and AS analysis. Show a diagram. 18. What are the causes of hyper-inflations? Of persistently high inflation rates? 19. How might a country stop a hyper-inflation? How might it bring down a persistently high inflation rate? Why are expectations critically important, and hinge on the credibility of the central bank, in bringing down a high inflation rate? 20. Why are discretionary policies more likely to lead to high inflation than nondiscretionary policies? 21. “Because increases in government spending shift out the AD curve, fiscal policy by itself can be the source of persistent inflation.” True, false, uncertain?