Question 1

According to the classical dichotomy, what changes nominal variables? What changes real variables?

Accepted Answer

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Question 2

Suppose the nominal interest rate is 5 percent, the tax rate on interest income is 30 percent, and the after-tax real interest rate is 2.1percent. Then the inflation rate is 2 percent.

Accepted Answer

The after-tax nominal interest rate is calculated by subtracting the tax impact from the nominal rate: 5% * (1 - 30%) = 3.5%. To find the inflation rate, we use the Fisher equation in its rearranged form: nominal rate - inflation rate = real rate. Here, we need to adjust the real rate back to its pre-tax value to make it comparable. Given the after-tax real rate is 2.1%, and this is after a 30% tax, the pre-tax real rate would be higher. However, without adjusting for this, simply using the given after-tax real rate and the after-tax nominal rate directly to find inflation would not yield the correct inflation rate directly. The calculation provided does not directly lead to determining the inflation rate as 2%.

Question 3

A person received 4% nominal interest. The inflation rate was -2% and the tax rate was 25%. This person received an after-tax real interest rate of 5%.

Accepted Answer

Nominal interest rate = 4%
Inflation rate = -2%
Tax rate = 25%

After-tax real interest rate = (1 + nominal interest rate)/(1 + inflation rate) * (1 - tax rate) - 1

= (1 + 0.04)/(1 - 0.02) * (1 - 0.25) - 1

= 1.05

Therefore, the statement is true.

Question 4

Wages and prices are many times higher today than they were 30 years ago, yet people do not work a lot more hours or buy fewer goods. How can this be?

Accepted Answer

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Question 5

The story The Wizard of Oz can be interpreted as an allegory about U.S. monetary policy in the late 19th century.

Accepted Answer

The story has been interpreted by many scholars as an allegory for the political and economic issues of the time, including the debate over gold and silver currency and the struggle between the East Coast and the West Coast for political power. The characters can represent different groups or individuals involved in the debates, such as the Tin Man as the industrial workers and the Scarecrow as the farmers. The Wizard himself can symbolize the government or the banking system, and his ability to create money out of thin air can be seen as a commentary on the power of monetary policy.

Question 6

Explain the adjustment process in the money market that creates a change in the price level when the money supply increases.

Accepted Answer

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Question 7

Inflation necessarily distorts saving when either real interest income or nominal interest income is taxed.

Accepted Answer

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Question 8

Suppose the Fed sells government bonds. Use a graph of the money market to show what this does to the value of money.

Accepted Answer

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Question 9

Inflation distorts savings when real interest income, rather than nominal interest income, is taxed.

Accepted Answer

The answer of Inflation distorts savings when real interest income,...

Question 10

Using separate graphs, demonstrate what happens to the money supply, money demand, the value of money, and the price level if:
a.the Fed increases the money supply.
b.people decide to demand less money at each value of money.

Accepted Answer

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Question 11

Define each of the symbols and explain the meaning of M  V = P  Y.

Accepted Answer

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Question 12

Even though monetary policy is neutral in the short run, it may have profound real effects in the long run.

Accepted Answer

Monetary policy is typically considered neutral in the long run, meaning it does not have a permanent effect on real variables such as output or employment, but it can have significant real effects in the short run due to price and wage rigidities.

Question 13

If the Fed were to unexpectedly increase the money supply, creditors would gain at the expense of debtors.

Accepted Answer

When the Fed unexpectedly increases the money supply, it typically leads to inflation or a decrease in the value of money, which benefits debtors as they can repay their loans with money that is worth less. Creditors, on the other hand, lose because the value of the repayments they receive has decreased.

Question 14

Why did farmers in the late 1800s dislike deflation?

Accepted Answer

The answer of Why did farmers in the late 1800s...

Question 15

If inflation is higher than expected, then lenders receive interest payments whose real values are less than they expected.

Accepted Answer

This is because inflation reduces the purchasing power of money over time. If the inflation rate is higher than the interest rate on a loan, the lender will effectively receive less value in real terms than they expected.

Question 16

If inflation is higher than expected, then borrowers make nominal interest payments that are less than they expected.

Accepted Answer

If inflation is higher than expected, the real value of the payments made by borrowers is less, but the nominal amount of their payments does not change based on inflation expectations.

Question 17

Suppose the nominal interest rate is 5 percent, the tax rate on interest income is 30 percent, and the after-tax real interest rate is 0.8 percent. Then the inflation rate is 2.7 percent.

Accepted Answer

To calculate the inflation rate, we can use the Fisher equation:
(1 + nominal interest rate) = (1 + real interest rate) x (1 + inflation rate)
Plugging in the given values:
(1 + 0.05) = (1 + 0.008) x (1 + inflation rate)
Solving for inflation rate:
inflation rate = 0.027, or 2.7 percent. Therefore, the given statement is true.

Question 18

In the late 1800's deflation caused farmers to suffer as the fall in crop prices reduced their income and thus their ability to pay off their debts.

Accepted Answer

This is a well-documented historical fact.

Question 19

Suppose the nominal interest rate is 10 percent, the tax rate on interest income is 28 percent, and the inflation rate is 6 percent. Then the after-tax real interest rate is -3.2 percent.

Accepted Answer

To calculate the after-tax real interest rate, we need to subtract the inflation rate and the tax rate on the nominal interest rate. 
After-tax real interest rate = (1 + nominal interest rate) / (1 + inflation rate) x (1 - tax rate) - 1

Using the given values: 
After-tax real interest rate = (1 + 0.1) / (1 + 0.06) x (1 - 0.28) - 1 = -0.0343 or -3.43%

Therefore, the after-tax real interest rate is not -3.2%, making option B the correct answer.

Question 20

Inflation is costly only if it is unanticipated.

Accepted Answer

Inflation, whether anticipated or unanticipated, can be costly. Anticipated inflation can lead to resources being used for inflation protection rather than productive investments, while unanticipated inflation can distort price signals and redistribute wealth unpredictably.

Quiz 17: Money Growth and Inflation