Using Okun’s law, fill in the four pieces of missing data in the table below. The data are hypothetical.
Natural unemployment rate (%)
Actual unemployment rate (%)
- C = 800 + mpc(Y – T)“C” is consumption, and “Y” is real GDP
- T = 1000 “T” is taxes minus transfers
- G = 900 “G” is government purchases
- IP = 600 “IP” is planned investment
- NX = 0 “NX” is net exports
- mpc = 0.8 “mpc” = the marginal propensity to consume
Suppose that the economy started out at its potential, so that the short-run equilibrium level of GDP that you found above is equal to potential GDP. Now suppose that businesses suddenly become pessimistic about future consumer demand, and planned investment (IP) falls from 600 to 500. Prices, wages, and interest rates are stuck at their old levels, and the marginal propensity to consume does not change. (Assume that all of these things are true for the rest of the question).
a) Suppose the Fed conducts an open market operation which sells $15 billion in bonds that banks buy with their reserves. Assume that people do not hold onto any currency outside of banks -- they re-deposit it as soon as they get it. Will the Fed’s action cause the money supply to increase or decrease? By how much? What will the total money supply be after this occurs?
b) Suppose that after what happens in (a), the Fed decides to reduce the required reserve-deposit ratio to 10%. Will this increase or decrease the money supply? By how much? What is the total money supply now?
a) The Fed’s bond traders buy bonds in an open market operation.
b) A bank panic hits the nation. People try to take all the money out of their checking accounts so they can hold it as cash.
c) Rising oil prices cause an increase in inflation.
Principles of Macroeconomics by Robert H. Frank and Ben S. Bernanke 5th edition
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