HOMEWORK #4DUE 6/20/18

Econ 1A – Spring 2018

1. Suppose a country’s debt is $630 billion before Year 1. Using the information below (in billions of dollars), fill in the blanks for its budget balance and debt for the following years:

2. What are the two ways that a government can finance a budget deficit?

3. Calculate the real deficit or surplus in the following cases:

⦁ Inflation is 10 percent. Debt is $3 trillion. Nominal deficit is $220 billion.

⦁ Inflation is −4 percent (price levels are falling). Debt is $500 billion. Nominal deficit is $30 billion.

4. Assume a country’s nominal debt is $360 billion. Inflation is 3 percent and interest rates are 6 percent. Calculate the debt service payments.

5. According to the Ricardian equivalence theorem, what is the effect on output of a government paying for an increase in spending by issuing bonds (borrowing to spend)?

6. Define automatic stabilizers. List the three that we talked about in lecture.

7. Briefly explain how automatic stabilizers work in:

⦁ Recessionary periods

⦁ Inflationary periods

8. Draw the AS/AD model and the Loanable Funds market side by side. Show graphically how government deficit spending can lead to “crowding out.” Briefly explain.

9. The government has just increased taxes. Demonstrate the effect on the price level and output in the AS/AD model.

10. What are the two tools of fiscal policy? What action would the government take with each tool to engage in expansionary monetary policy? Demonstrate this in the AS/AD model.

11. What are the three functions of money? Briefly describe each.

12. How does inflation affect money’s function as a store of wealth?

13. While John is walking to campus one morning, a helicopter flying overhead drops a $100 bill. Not knowing how to return it, John keeps the money and deposits it into his bank. If the bank keeps 5% of its money in reserves:

⦁ How much money can the bank initially lend out?

⦁ What is the money multiplier in this scenario?

⦁ How much new money will eventually be created by the banking system as a result of John’s initial $100 deposit?

14. List the three tools of monetary policy. What action would the Fed take with each tool to engage in contractionary monetary policy?

15. Use the Money Market graph and the AS/AD model to demonstrate the effect of expansionary monetary policy when the economy is:

⦁ Below potential output.

⦁ Significantly above potential output.

16. Explain how the Fed uses open market operations to increase the money supply?

17. Write out the Taylor rule. What does the rule predict will happen to the Federal funds rate target in the situations below?

⦁ Inflation is 2 percent, the inflation target is 3 percent, and output is 2 percent below potential.

⦁ Inflation is 4 percent, the inflation target is 2 percent, and output is 3 percent above potential.