David K.H. Begg, Gianluigi Vernasca-Economics-McGraw Hill Higher Education (2011)

CHAPTER 19 Interest rates and monetary transmission
is no inflation, what is your permanent income? (c) Using your diagram, or otherwise, identify
your saving or dissaving in each period of your life. (d) If the real interest rate is positive instead of
zero, what effect does this have on your initial estimate of your permanent income? Illustrate in
your diagram.
11 Consider a simplified vesion of the model in Maths 19.1, in which money demand, the deposit
multiplier and aggregate demand are, respectively:
M=Y-r M=mR Y= 100 - r
(a) If output is 90, find the interest rate and bank reserves levels. (b) Suppose autonomous aggregate
demand falls from 100 to 95, and the deposit multiplier falls from m to m/2. How much must
reserves increase to preserve the initial level of output? ( c) What is the maximum fall in autonomous
aggregate demand that can be offset by quantitative easing?
12 Why might it take up to two years for a change in interest rates fully to affect aggregate demand?
What does this imply about decisions to set interest rates?
1 3 If the permanent income hypothesis is correct, we should expect to see a lower marginal propensity
to consume in the short run than in the long run. Why?
14 Essay question Why do modern central banks think of monetary policy as choosing the interest
rate rather than the money supply?
For solutions to these questions contact your lecturer.
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