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Chapter 22: Q. 13 (page 582)

For each of the following situations, describe how (if at all) the IS, MP, and AD curves are affected.

a. A decrease in financial frictions

b. An increase in taxes and an autonomous easing of monetary policy

c. An increase in the current inflation rate

d. A decrease in autonomous consumption

e. Firms become more optimistic about the future of the economy.

f. The new Federal Reserve chair begins to care more about fighting inflation.

Short Answer

Expert verified

a. IS curve moves to the right, MP curves remain the same

b. IS curve remains the same, MP curve moves to left,

c. IS and MP shift to the left, Ad moves right

d. IS shifts to the left, MP unaffected, AD moves left

e. IS moves to right, MP unaffected, AD moves right

f. IS moves left, MP moves right, AD moves left

Step by step solution

01

Step :1  Introduction 

The investment saving curve or IS curve shows the different combinations of income and interest rate at which the market for goods is at equilibrium. MP curve shows the different combinations of inflation and interest rate at which the money market is in equilibrium.

02

Step :2 Decrease in financial frictions  (part a) 

a) Minimizing economic motion causes the IS curve to shift to the right, the MP curve to remain unchanged, and the AD curve to demographic shift.

03

Step :3 Increase in taxes and an autonomous  (part b) 

b) The surtax induces the Equilibrium point to shift to the left, while the IS curve stays the same and the MP curve shifts to the left.

04

Step :4 The current inflation rate (part c) 

As the present inflation rate rises, the MP and IS curves shift to the left, while the AD curve shifts to the right.

05

Step : 5 Decrease in autonomous consumption (part d )

d) Reducing autonomous consumption causes the AD and IS slopes to shift to the left, but has no consequence on the MP curve.

06

Step :6 future of the economy (part e)  

e) Beneficial firm behavior symbolizes the resurgence of so-called animal spirits, which will cause the AD and IS curves to shift to the right, but the MP curve has no effect.

07

Step : 7 fighting inflation (part f)

f) Anxiety about inflation is seen as an independent tightening of monetary policy, resulting in a movement to the left of the IS and AD curves and a rightward shift of the MP curve.

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Most popular questions from this chapter

Go to https://www.federalreserve.gov/monetarypolicy/ files/FOMC_LongerRunGoals.pdf. Review the FOMC鈥檚 document, 鈥淟onger-Run Goals and Monetary Policy Strategy.鈥� Explain why these goals are consistent with the Taylor principle.

How is an autonomous tightening or easing of monetary policy different from a change in the real interest rate caused by a change in the current inflation rate?

Suppose that a new Fed chair is appointed and that his or her approach to monetary policy can be summarized by the following statement: "I care only about increasing employment. Inflation has been at very low levels for quite some time; my priority is to ease monetary policy to promote employment." How would you expect the monetary policy curve to be affected, if at all?

Assume that the monetary policy curve is given by

r = 1.5 + 0.75p.

a. Calculate the real interest rate when the inflation rate

is 2%, 3%, and 4%.

b. Draw a graph of the MP curve, labeling the points

from part (a).

c. Assume now that the monetary policy curve is given

by r = 2.5 + 0.75p. Does the new monetary policy

curve represent an autonomous tightening or loosening

of monetary policy?

d. Calculate the real interest rate when the inflation rate

is 2%, 3%, and 4%, and draw the new MP curve,

showing the shift from part (b).

A measure of real interest rates can be approximatedby the Treasury Inflation-Indexed Security, or TIIS.Go to the St. Louis Federal Reserve FRED database,and find data on the five-year TIIS (FII5) and the personal consumption expenditure price index

(PCECTPI), a measure of the price index. Choose鈥淨uarterly鈥� for the frequency setting of the TIIS,and download both data series. Convert the priceindex data to annualized inflation rates by taking thequarter-to-quarter percent change in the price indexand multiplying it by 4. Be sure to multiply by 100so that your results are percentages.

a. Calculate the average inflation rate andthe average real interest rate over the most

recent four quarters of data available and the four quarters prior to that.

b. Calculate the change in the average inflation rate between the most recent annual

period and the year prior. Then calculate the change in the average real interest rate

over the same period.

c. Using your answers to part (b), compute the ratio of the change in the average real interest

rate to the change in the average inflation rate. What does this ratio represent? Comment on

how it relates to the Taylor principle
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