Econ203-Tut9 Vinh Nguyen Taylor Rule Question 3 Reference(s)

Econ 203 Lect A, Tut C - Tutorial 9

Tutor: Vinh Nguyen1 (vinhcit@gmail.com)
1 Concordia

University

Mar 20, 2012

Econ203-Tut9 Vinh Nguyen Taylor Rule Question 3 Reference(s)

Monetary Policy Targets and Instrument in Canada

Targets:

Econ203-Tut9 Vinh Nguyen Taylor Rule Question 3 Reference(s)

Monetary Policy Targets and Instrument in Canada

Targets: Foreign exchange rate (1960s)

Econ203-Tut9 Vinh Nguyen Taylor Rule Question 3 Reference(s)

Monetary Policy Targets and Instrument in Canada

Targets: Foreign exchange rate (1960s) Money supply (1970s early 1990s)

Econ203-Tut9 Vinh Nguyen Taylor Rule Question 3 Reference(s)

Monetary Policy Targets and Instrument in Canada

Targets: Foreign exchange rate (1960s) Money supply (1970s early 1990s) Ination rate (early 1990s present)

Econ203-Tut9 Vinh Nguyen Taylor Rule Question 3 Reference(s)

Monetary Policy Targets and Instrument in Canada

Targets: Foreign exchange rate (1960s) Money supply (1970s early 1990s) Ination rate (early 1990s present) Instrument: interest rate. In Canada: overnight rate (the

interest rate large nancial institutions receive or pay on loans from one day until the next)

Econ203-Tut9 Vinh Nguyen Taylor Rule Question 3 Reference(s)

Monetary Policy Targets and Instrument in Canada

Targets: Foreign exchange rate (1960s) Money supply (1970s early 1990s) Ination rate (early 1990s present) Instrument: interest rate. In Canada: overnight rate (the

interest rate large nancial institutions receive or pay on loans from one day until the next)
A relationship:

bank rate overnight rate + 0.25%

Econ203-Tut9 Vinh Nguyen Taylor Rule Question 3 Reference(s)

Monetary Policy Targets and Instrument in Canada

Targets: Foreign exchange rate (1960s) Money supply (1970s early 1990s) Ination rate (early 1990s present) Instrument: interest rate. In Canada: overnight rate (the

interest rate large nancial institutions receive or pay on loans from one day until the next)
A relationship:

bank rate overnight rate + 0.25%

Overnight rate commercial bank lending rates

expansion in the money supply

Econ203-Tut9 Vinh Nguyen Taylor Rule Question 3 Reference(s)

Taylor Rule

Taylor Rule:

i = i0 + a ( ) + b (Y Yp )
>0 >0

where is the banks target ination rate and i0 is the target nominal interest

Econ203-Tut9 Vinh Nguyen Taylor Rule Question 3 Reference(s)

Taylor Rule

Taylor Rule:

i = i0 + a ( ) + b (Y Yp )
>0 >0

where is the banks target ination rate and i0 is the target nominal interest
Long-run change: change in i0

Econ203-Tut9 Vinh Nguyen Taylor Rule Question 3 Reference(s)

Taylor Rule

Taylor Rule:

i = i0 + a ( ) + b (Y Yp )
>0 >0

where is the banks target ination rate and i0 is the target nominal interest
Long-run change: change in i0 Short-run change: temporarily set the nominal rate to i

Econ203-Tut9 Vinh Nguyen Taylor Rule Question 3 Reference(s)

Question 1(i)(iv)
Were given:

i = i0 + ( ) + (Y Yp )

where

= 2%

Econ203-Tut9 Vinh Nguyen Taylor Rule Question 3 Reference(s)

Question 1(i)(iv)
Were given:

i = i0 + ( ) + (Y Yp )

where

= 2%

(i) With i0 = 9%, = , Y = Yp , it must be that

i = i0 = 9%.

Econ203-Tut9 Vinh Nguyen Taylor Rule Question 3 Reference(s)

Question 1(i)(iv)
Were given:

i = i0 + ( ) + (Y Yp )

where

= 2%

(i) With i0 = 9%, = , Y = Yp , it must be that

i = i0 = 9%.
(ii) Now, we have Y Yp = 5% and = . Then,

i = i0 5% = 4%.

Econ203-Tut9 Vinh Nguyen Taylor Rule Question 3 Reference(s)

Question 1(i)(iv)
Were given:

i = i0 + ( ) + (Y Yp )

where

= 2%

(i) With i0 = 9%, = , Y = Yp , it must be that

i = i0 = 9%.
(ii) Now, we have Y Yp = 5% and = . Then,

i = i0 5% = 4%.
(iii) i dropping shifts the AD and AS curves up (see

Figure 10.8 on page 260)

Econ203-Tut9 Vinh Nguyen Taylor Rule Question 3 Reference(s)

Question 1(i)(iv)
Were given:

i = i0 + ( ) + (Y Yp )

where

= 2%

(i) With i0 = 9%, = , Y = Yp , it must be that

i = i0 = 9%.
(ii) Now, we have Y Yp = 5% and = . Then,

i = i0 5% = 4%.
(iii) i dropping shifts the AD and AS curves up (see

Figure 10.8 on page 260)

(iv) i was 9% and now i = 4%, so i = 5%. Thus,

= 1.5i = 2% 1.5(5%) = 9.5%

Econ203-Tut9 Vinh Nguyen Taylor Rule Question 3 Reference(s)

Question 1(v),(vi)
Again:

i = i0 + ( ) + (Y Yp )

where

= 2%

Econ203-Tut9 Vinh Nguyen Taylor Rule Question 3 Reference(s)

Question 1(v),(vi)
Again:

i = i0 + ( ) + (Y Yp )

where

= 2%

(v) Now = 1.5i, so = 1.5i. First,

notice: inew = i0 1.5i + (Y Yp ) = iold 1.5i + (Y Yp )

Econ203-Tut9 Vinh Nguyen Taylor Rule Question 3 Reference(s)

Question 1(v),(vi)
Again:

i = i0 + ( ) + (Y Yp )

where

= 2%

(v) Now = 1.5i, so = 1.5i. First,

notice: inew = i0 1.5i + (Y Yp ) = iold 1.5i + (Y Yp )

It follows that

i = 1.5i + (Y Yp )

2.5i = (Y Yp )

Econ203-Tut9 Vinh Nguyen Taylor Rule Question 3 Reference(s)

Question 1(v),(vi)
Again:

i = i0 + ( ) + (Y Yp )

where

= 2%

(v) Now = 1.5i, so = 1.5i. First,

notice: inew = i0 1.5i + (Y Yp ) = iold 1.5i + (Y Yp )

It follows that

i = 1.5i + (Y Yp )

2.5i = (Y Yp )

With Y Yp = 5%, it must be that i = 2%. So

inew = iold + i = 9% 2% = 7%

Econ203-Tut9 Vinh Nguyen Taylor Rule Question 3 Reference(s)

Question 1(v),(vi)
Again:

i = i0 + ( ) + (Y Yp )

where

= 2%

(v) Now = 1.5i, so = 1.5i. First,

notice: inew = i0 1.5i + (Y Yp ) = iold 1.5i + (Y Yp )

It follows that

i = 1.5i + (Y Yp )

2.5i = (Y Yp )

With Y Yp = 5%, it must be that i = 2%. So

inew = iold + i = 9% 2% = 7%
(vi) We have = 1.5i = 2% 1.5(2%) = 5%.

Econ203-Tut9 Vinh Nguyen Taylor Rule Question 3 Reference(s)

Question 1(vii) and MC 6 from Tut 8

(vii) Lowering interest rate creates an upward pressure on

ination.

Econ203-Tut9 Vinh Nguyen Taylor Rule Question 3 Reference(s)

Question 1(vii) and MC 6 from Tut 8

(vii) Lowering interest rate creates an upward pressure on

ination.
When is taken into account, the BoC is more careful

with lowering the interest so as to not raising too high. Thus, i (part (v)) is higher than i (part (ii)).

Econ203-Tut9 Vinh Nguyen Taylor Rule Question 3 Reference(s)

Question 1(vii) and MC 6 from Tut 8

(vii) Lowering interest rate creates an upward pressure on

ination.
When is taken into account, the BoC is more careful

with lowering the interest so as to not raising too high. Thus, i (part (v)) is higher than i (part (ii)). MC 6 from Tut 8. Long term eects allude to change in potential output, so (C) is a right choice.

Econ203-Tut9 Vinh Nguyen Taylor Rule Question 3 Reference(s)

Question 1(vii) and MC 6 from Tut 8

(vii) Lowering interest rate creates an upward pressure on

ination.
When is taken into account, the BoC is more careful

with lowering the interest so as to not raising too high. Thus, i (part (v)) is higher than i (part (ii)). MC 6 from Tut 8. Long term eects allude to change in potential output, so (C) is a right choice.
SRAS is a temporary measure to maintain the overnight

rate so (A) is wrong. Correction: [I misread SRAS into SPRA] In any case, SRAS = short-run aggregate supply, which has little to do with long term potential output, so (A) is not the right choice.

Econ203-Tut9 Vinh Nguyen Taylor Rule Question 3 Reference(s)

Question 1(vii) and MC 6 from Tut 8

(vii) Lowering interest rate creates an upward pressure on

ination.
When is taken into account, the BoC is more careful

with lowering the interest so as to not raising too high. Thus, i (part (v)) is higher than i (part (ii)). MC 6 from Tut 8. Long term eects allude to change in potential output, so (C) is a right choice.
SRAS is a temporary measure to maintain the overnight

rate so (A) is wrong. Correction: [I misread SRAS into SPRA] In any case, SRAS = short-run aggregate supply, which has little to do with long term potential output, so (A) is not the right choice. AD can be shifted without any change to potential output (see Figure 10.8, page 260). (B) is also wrong.

Econ203-Tut9 Vinh Nguyen Taylor Rule Question 3 Reference(s)

Question 1(vii) and MC 6 from Tut 8

(vii) Lowering interest rate creates an upward pressure on

ination.
When is taken into account, the BoC is more careful

with lowering the interest so as to not raising too high. Thus, i (part (v)) is higher than i (part (ii)). MC 6 from Tut 8. Long term eects allude to change in potential output, so (C) is a right choice.
SRAS is a temporary measure to maintain the overnight

rate so (A) is wrong. Correction: [I misread SRAS into SPRA] In any case, SRAS = short-run aggregate supply, which has little to do with long term potential output, so (A) is not the right choice. AD can be shifted without any change to potential output (see Figure 10.8, page 260). (B) is also wrong. (D) refers to temporary techniques. (D) is not correct.

Econ203-Tut9 Vinh Nguyen Taylor Rule Question 3 Reference(s)

Question 3(i)(iv)

(i) At equilibrium, M s = M d so i = 0.05. As such, I = 95

and Y = 1375. (Note: C = 100 + 0.8(Y 150)).

Econ203-Tut9 Vinh Nguyen Taylor Rule Question 3 Reference(s)

Question 3(i)(iv)

(i) At equilibrium, M s = M d so i = 0.05. As such, I = 95

and Y = 1375. (Note: C = 100 + 0.8(Y 150)).

(ii) C = 1080, and S = Y T C = 145.

Econ203-Tut9 Vinh Nguyen Taylor Rule Question 3 Reference(s)

Question 3(i)(iv)

(i) At equilibrium, M s = M d so i = 0.05. As such, I = 95

and Y = 1375. (Note: C = 100 + 0.8(Y 150)).

(ii) C = 1080, and S = Y T C = 145. (iii) Note that

Y =C +I +G

Y C T I =G T

Note that Y C T = S so we have S I = G T . This means the government decit can be nanced by borrowing from private savings.

Econ203-Tut9 Vinh Nguyen Taylor Rule Question 3 Reference(s)

Question 3(i)(iv)

(i) At equilibrium, M s = M d so i = 0.05. As such, I = 95

and Y = 1375. (Note: C = 100 + 0.8(Y 150)).

(ii) C = 1080, and S = Y T C = 145. (iii) Note that

Y =C +I +G

Y C T I =G T

Note that Y C T = S so we have S I = G T . This means the government decit can be nanced by borrowing from private savings.
1 (iv) Multiplier 1c = 5. So with G = 50, Y = 250,

thus new Y = 1375 + 250 = 1625.

Econ203-Tut9 Vinh Nguyen Taylor Rule Question 3 Reference(s)

Question 3(v)(vii)
(v) Solve the system

Y = 100 + 0.8(Y 150) + 120 500i + 200 100 = 200 2000i + 0.1Y We get i = 0.111111 and Y = 1222.22.

Econ203-Tut9 Vinh Nguyen Taylor Rule Question 3 Reference(s)

Question 3(v)(vii)
(v) Solve the system

Y = 100 + 0.8(Y 150) + 120 500i + 200 100 = 200 2000i + 0.1Y We get i = 0.111111 and Y = 1222.22. (vi) Solve the system Y = 100 + 0.8(Y 150) + 120 500i + 250 100 = 200 2000i + 0.1Y Answers: i = 0.122222 and Y = 1444.44

Econ203-Tut9 Vinh Nguyen Taylor Rule Question 3 Reference(s)

Question 3(v)(vii)
(v) Solve the system

Y = 100 + 0.8(Y 150) + 120 500i + 200 100 = 200 2000i + 0.1Y We get i = 0.111111 and Y = 1222.22. (vi) Solve the system Y = 100 + 0.8(Y 150) + 120 500i + 250 100 = 200 2000i + 0.1Y Answers: i = 0.122222 and Y = 1444.44 (vii) Note that from (v) to (vi), i has gone up, so I has gone down. Specically, I = 5.55. Note also that before (in (iv)), G = 50 leads to Y = 250. Now (in (v), (vi)), G = 50 leads to Y = 222.22. So the scal policy is now less eective in aecting Y .

Econ203-Tut9 Vinh Nguyen Taylor Rule Question 3 Reference(s)

Question 3(viii)

(viii) We have

Y = 100 + 0.8(Y 150) + I + G = 20 + 0.8Y + I + G

Econ203-Tut9 Vinh Nguyen Taylor Rule Question 3 Reference(s)

Question 3(viii)

(viii) We have

Y = 100 + 0.8(Y 150) + I + G = 20 + 0.8Y + I + G

Therefore,

Y = 100 + 5(I + G )

Y = 5(I + G )

Econ203-Tut9 Vinh Nguyen Taylor Rule Question 3 Reference(s)

References

Curtis, Douglas; Irvine, Ian and Begg, David. Macroeconomics. 2nd Canadian edition, USA: McGraw-Hill Ryerson, 2010.