Question 4 (3 + 4 + 3 = 10 p.) As a new macroeconomic expert at...

Question 4 (3 + 4 + 3 = 10 p.) As a new macroeconomic expert at the Central bank, you are asked to answer the following questions:

a) Why does a Central bank not have complete control over the size of the money supply? Give two reasons.

b) Assume that the inflation rates over three time periods are 1 percent, 2 percent, and 4 percent. Nominal interest rates in the same three periods are 5 percent, 5 percent, and 6 percent, respectively.

i) What are the ex post real interest rates in the three periods?

ii) If the expected inflation rate in each period is the realized inflation rate in the previous period, what are the ex ante real interest rates in periods 2 and 3?

iii) If someone lends money in period 2, based on the ex ante inflation expectation in part (ii), will he or she be pleasantly or unpleasantly surprised in period 3 when the loan is repaid? Why?

c) If the Central bank wants to stimulate the economy (and reduce the unemployment) in good times and contract the economy (and reduce inflation) in bad times. What is preferable: that the population has adaptive expectations or rational expectations? Discuss shortly.

Expert Solution

Rahul Sunny answered 2 years ago

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