The Economics of Money, Banking, and Financial Markets

Frederic S. Mishkin

Chapter 19

Quantity Theory, Inflation, and the Demand for Money - all with Video Answers

Educators

Chapter Questions

Problem 1

How would you expect velocity to typically behave over the business cycle?

Md.Daniyal Arshad

Md.Daniyal Arshad

Numerade Educator

Problem 2

If velocity and aggregate output are reasonably constant (as the classical economists believed), what happens to the price level when the money supply increases from
$\$ 1$ trillion to $\$ 4$ trillion?

Md.Daniyal Arshad

Md.Daniyal Arshad

Numerade Educator

Problem 3

If credit cards were made illegal by congressional legislation, what would happen to velocity? Explain your answer.

Prashant Bana

Numerade Educator

Problem 4

"If nominal GDP rises, velocity must rise." Is this statement true, false, or uncertain? Explain your answer.

Kaylee Mcclellan

Kaylee Mcclellan

Numerade Educator

Problem 5

Why would a central bank be concerned about persistent, long-term budget deficits?

Aryan Tiwari

Numerade Educator

Problem 6

"Persistent budget deficits always lead to higher inflation." Is this statement true, false, or uncertain? Explain your answer.

Md.Daniyal Arshad

Md.Daniyal Arshad

Numerade Educator

Problem 7

Suppose a new "payment technology" allows individuals to make payments using U.S. Treasury bonds (i.e., U.S. Treasury bonds are immediately cashed when needed to make a payment and that balance is transferred to the payee). How do you think this payment technology would affect the transaction components of the demand for money?

Kaylee Mcclellan

Kaylee Mcclellan

Numerade Educator

Problem 8

The use of some payment technologies requires some infrastructure (e.g., merchants need to have access to credit card swiping machines). In most developing countries, this infrastructure is either nonexistent or very costly. Everything else being the same, would you expect the transaction component of the demand for money to be greater or smaller in a developing country than in a rich country?

Md.Daniyal Arshad

Md.Daniyal Arshad

Numerade Educator

Problem 9

What three motives for holding money did Keynes consider in his liquidity preference theory of the demand for real money balances? On the basis of these motives, what variables did he think determined the demand for money?

Kaylee Mcclellan

Kaylee Mcclellan

Numerade Educator

Problem 10

In many countries, people hold money as a cushion against unexpected needs arising from a variety of potential scenarios (e.g., banking crises, natural disasters, health problems, unemployment, etc.) that are not usually covered by insurance markets. Explain the effect of such behavior on the precautionary component of the demand for money.

Kaylee Mcclellan

Kaylee Mcclellan

Numerade Educator

Problem 11

In Keynes's analysis of the speculative demand for money, what will happen to money demand if people suddenly decide that the normal level of the interest rate has declined? Why?

Md.Daniyal Arshad

Md.Daniyal Arshad

Numerade Educator

Problem 12

Why is Keynes's analysis of the speculative demand for money important to his view that velocity will undergo substantial fluctuations and thus cannot be treated as constant?

Kaylee Mcclellan

Kaylee Mcclellan

Numerade Educator

Problem 13

According to the portfolio theories of money demand, what are the four factors that determine money demand? What changes in these can increase the demand for money?

Kaylee Mcclellan

Kaylee Mcclellan

Numerade Educator

Problem 14

Explain how the following events will affect the demand for money according to the portfolio theories of money demand:
a. The economy experiences a business cycle contraction.
b. Brokerage fees decline, making bond transactions cheaper
c. The stock market crashes (Hint: Consider both the increase in stock price volatility following a market crash and the decrease in wealth of stockholders.

Kaylee Mcclellan

Kaylee Mcclellan

Numerade Educator

Problem 15

Suppose a given country experienced low and stable inflation rates for quite some time, but then inflation picked up and over the past decade has been relatively high and quite unpredictable. Explain how this new inflationary environment would affect the demand for money according to portfolio theories of money demand. What would happen if the government decides to issue inflation-protected securities?

Md.Daniyal Arshad

Md.Daniyal Arshad

Numerade Educator

Problem 16

Consider the portfolio choice theory of money demand. How do you think the demand for money will be affected during a hyperinflation (i.e., monthly inflation rates in excess of $50 \%$ )?

Md.Daniyal Arshad

Md.Daniyal Arshad

Numerade Educator

Problem 17

Both the portfolio choice and Keynes's theories of the demand for money suggest that as the relative expected return on money falls, demand for it will fall. Why would the portfolio choice approach predict that money demand is unaffected by changes in interest rates? Why did Keynes think that money demand is affected by changes in interest rates?

Md.Daniyal Arshad

Md.Daniyal Arshad

Numerade Educator

Problem 18

Why does the Keynesian view of the demand for money suggest that velocity is unpredictable?

Kaylee Mcclellan

Kaylee Mcclellan

Numerade Educator

Problem 19

What evidence is used to assess the stability of the money demand function? What does the evidence suggest about the stability of money demand and how has this affected monetary policy making?

Md.Daniyal Arshad

Md.Daniyal Arshad

Numerade Educator

Problem 20

Suppose that a plot of the values of $\mathrm{M} 2$ and nominal GDP for a given country over 40 years shows that these two variables are very closely related. In particular, a plot of their ratio (nominal GDP/M2) yields very stable and easy-to-predict values. On the basis of this evidence, would you recommend the monetary authorities of this country to conduct monetary policy by focusing mostly on the money supply rather than on setting interest rates? Explain why.

Md.Daniyal Arshad

Md.Daniyal Arshad

Numerade Educator

Problem 21

Suppose the money supply $M$ has been growing at $10 \%$ per year, and nominal GDP, $P Y$, has been growing at $20 \%$ per year. The data are as follows (in billions of dollars):
Calculate the velocity in each year. At what rate is velocity growing?

Md.Daniyal Arshad

Md.Daniyal Arshad

Numerade Educator

Problem 22

Calculate what happens to nominal GDP if velocity remains constant at 5 and the money supply increases from $\$ 200$ billion to $\$ 300$ billion.

Md.Daniyal Arshad

Md.Daniyal Arshad

Numerade Educator

Problem 23

What happens to nominal GDP if the money supply grows by $20 \%$ but velocity declines by $30 \% ?$

Kaylee Mcclellan

Kaylee Mcclellan

Numerade Educator

Problem 24

If velocity and aggregate output remain constant at $\$ 5$ and $\$ 1,000$ billion, respectively, what happens to the price level if the money supply declines from $\$ 400$ billion to $\$ 300$ billion?

Rashmi Sinha

Numerade Educator

Problem 25

Suppose the liquidity preference function is given by
\[L(i, Y)=\frac{Y}{8}-1,000 i\]
Calculate velocity for each period, using the money demand equation, along with the following table of values

Jennifer Stoner

Jennifer Stoner

Numerade Educator