337 views

Uploaded by Jorge Rojas-Vallejos

Hi: This one is a simple but useful problem to see how expectations on the price level can affect the money growth and vice versa.

save

- Lecture No 03 SlidesLecture No. 03_ Technology and Innovation in Finance
- Chapter 1
- US Federal Reserve: h6
- money question.pdf
- US Federal Reserve: h6
- Inflation and CRR
- Blondie's Freegold Summary
- US Federal Reserve: 790427confcall
- lecture2.pdf
- Oliver Wyman_State of Financial Services Industry 2014
- 828.pdf
- money and banking
- Trade, Unemployment and Inequality
- Soluciones Ejercicios de Macro 1
- Happiness and Clean Air
- Notes on Econometrics
- Macroeconomic Theory Notes
- OLS estimators Econometrics
- Soluciones Set 1 Macro 1
- General Equilibrium and Welfare Economics
- Auctions, best responses, reactions functions, Nash Equilibria
- Economic Growth
- Turbulence characteristics of a Fluid
- The Inflation Tax in RBC: A revision
- Demanda, Oferta y Mercado
- Impact of Income Distribution on Economic Growth, Rojas and Khor
- Lógica y Teoría de Conjuntos.
- Ejercicios de Macroeconomía
- Problem Set 2
- calvo.pdf
- Public Economics and Public Administration
- OECD Analysis
- 301 March 16 2012 Solutions
- The Determinants of Growth - Nicholas Stern
- Airbus
- Perfect Competition Lecture Notes
- dis_rna_13
- Macro Review III
- Ch06 - Perfectly Competitive Markets
- industrial-development.pdf
- Long Wave Theories
- Assignment 3
- Kirman - Demand Theory and General Equilibrium-From Explanation to Introspection, A Journey Down the Wrong Road
- Midterm 2 With Solutions
- MBA WBUT Syllabus
- Factor Price Equalisation
- supply demand lesson
- Beaver, W 1968. the Information Content of Annual Earnings Announcements
- BEC 111 Principles of Micro Economics Module
- Perfect competition in market
- Mathematical Model of Islamic Economy
- Economic Instructor Manual
- -Commodity-Markets-Project.doc
- Chapter 1 Lecture Notes
- Shapiro (1997)
- Funeco 4 Equi Mdo
- Expectations and Exchange Rate Dynamics
- 4

You are on page 1of 5

by Jorge Rojas

Problem.

Consider the following money demand function, where all variables are in natural loga-

rithms.

mt − pt = − (Etpt+1 − pt) ∀t = 0, 1, 2, 3, (1)

Etpt+1 = pt+1 (perfect foresight) (2)

**where mt is the log of the money supply, pt is the log of the price level at t, and Etpt+1
**

the public’s expectation of pt+1 formed at time t.

(a)

Suppose that mt = 10 for t = 0, 1, 2, 3, . Using lag operators compute the equilibrium

value for pt for t = 0, 1, 2, 3, 4, 5.

We know that mt = 10 ∀t. From equations (1) and (2) we obtain as follows:

mt − pt = − (Etpt+1 − pt)

mt − pt = − (pt+1 − pt)

mt − pt = − pt+1 + pt

mt + pt+1 = 2 pt

1 1

⇒ pt = pt+1 + mt (3)

2 2

**We can see from equation (3) that pt will converge smoothly to a certain value p∗
**

through time because the coefficients for pt+1 and mt of the difference equation are

smaller than 1 and greater than zero.

We can write equation (3) in its general form as:

pt = φ pt+1 + ρ mt (4)

1 1

where φ = 2 and ρ = 2 .

We can rearrange equation (4) as follows:

⇒ pt − φ pt+1 = ρ mt

pt − φ L −1 pt = ρ mt

1 − φ L−1 pt = ρ mt

ρ

⇒ pt = mt (5)

(1 − φ L−1)

1

We also know that:

∞

X i 1

φ L−1 = ∀|φ| < 1 (6)

1 − φ L−1

i=0

**Therefore, combining (5) and (6):
**

" ∞

#

X i

pt = ρ φ L−1 mt

i=0

X∞

= ρ mt φi L−i

i=0

∞

X

= ρ φi L−i mt

i=0

∞

X

φi L−i mt

= ρ

i=0

∞

X

= ρ φi mt+i

i=0

**Therefore, we obtain equation (7)
**

∞

X

pt = ρ φi mt+i (7)

i=0

Now, we can use the fact that mt is constant and equal to ten for all periods of time.

Thus,

∞

X

pt = ρ m̄t φi (8)

i=0

**The sum in equation (8) is a geometric sum. In general, we know that:
**

n

X φk − φn+1

φi = (9)

1− φ

i=k

1

In our case we have that φ = 2 and n → ∞. Thus, equation (9) can be reduced to:

∞

X φk

φi = ∀|φ| < 1 (10)

1− φ

i=k

Applying equation (10) into (8) we obtain equation (11):

1 1

(b)pt = × 10 × 1

= 10 ∀t = 0, 1, 2, 3, . (11)

2 1− 2

**Therefore, the equilibrium value for pt is constant and equal to 10. Notice that mt is
**

also 10 for every period of time.

2

(b)

Suppose now that the path for mt is:

mt = 10 t = 0, 1, 2, 3

mt = 12 t = 4, 5, 6, 7

**Compute the equilibrium values of pt for t = 0, 1, 2, 3, 4, 5, 6. How does this time path for
**

pt compare with that compute in part (a)? Plot the time paths.

**The expression given in equation (7) in part (a) is a valid in general. In the new case,
**

we have that mt is constant and equal to 10 for t = 0, 1, 2, 3 and then increases to 12 per-

manently.

**Let us calculate the value for p0. To do so we will use the identity given in equation (10)
**

1

and the values for ρ = 2 = φ.

∞

X

p0 = ρ φi m0+i

i=0

∞

X

= ρ φ mi

"i=0 ∞

#

X

= ρ m0 + φ m1 + φ2 m 2+ φ3 m3 + φi mi

" i=4 #

∞

X

= ρ m0 + φ m1 + φ2 m2 + φ3 m3 + m̄4 φi ; m̄4: constant

i=4

φ4

= ρ m0 + φ m1 + 2+ φ2 m φ3 m3 + m̄4

1− φ

" 2 3 #

1 1 1 1 1/2)4

= × 10 + × 10 + × 10 + × 10 + 12 ×

2 2 2 2 1 − (1/2)

81

=

8

p0 = 10.125

We proceed in a similar way for p1, p2, p3, p4, p5 and p6.

∞

X

⇒ p1 = ρ φi m1+i

"i=0 ∞

#

X

= ρ m1 + φ m2 + φ2 m3 + φi m1+i

" i=3 #

∞

X

= ρ m1 + φ m2 + φ2 m3 + m̄4 φi ; m̄4 = 12

i=3

φ3

= ρ m1 + φ m2 + φ2 m3 + m̄4

1− φ

3

" 2 #

1 1 1 1/2)3 41

= × 10 + × 10 + × 10 + 12 × =

2 2 2 1 − (1/2) 4

p1 = 10.25

∞

X

⇒ p2 = ρ φi m2+i

"i=0 ∞

#

X

= ρ m2 + φ m3 + φi m2+i

" i=2 #

∞

X

= ρ m2 + φ m3 + m̄4 φi ; m̄4 = 12

i=2

φ2

= ρ m2 + φ m3 + m̄4

1− φ

" #

2

1 1 (1/2)

= × 10 + × 10 + 12 ×

2 2 1 − (1/2)

21

=

2

p2 = 10.5

∞

X

⇒ p3 = ρ φi m3+i

"i=0 ∞

#

X

= ρ m3 + φi m3+i

" i=1 #

∞

X

= ρ m3 + m̄4 φi ; m̄4 = 12

i=1

φ

= ρ m3 + m̄4

1− φ

1 (1/2)

= × 10 + 12 ×

2 1 − (1/2)

p3 = 11

∞

X

⇒ p4 = ρ φi m4+i

i=0

∞

X

= ρ m̄4 φi ; m̄4 = 12

i=0

1

= ρ m̄4

1−φ

1 1

= × 12 ×

2 1 − (1/2)

p4 = 12

**We can see that after t = 4 the value of mt is constant, and therefore, the problem is
**

reduced to the answer in part (a). In other words, the equilibrium pt will be constant

and equal to mt. Thus, we have that p5 = p6 =

= pn = 12 ∀n > 4.

4

Figure 1.

From figure 1, we can see that the increase in the money supply has a clear effect on the

price level, but this effect is smoothly done. In other words, the increase in money

supply in period four and afterwards has its complete effect after 4 periods. The loga-

ritm of the price level, pt increases slowly from 10 to the new steady state at 12. Unlike,

part (a) in which the money supply is constant, and hence pt is also constant.

5

- Lecture No 03 SlidesLecture No. 03_ Technology and Innovation in FinanceUploaded byfinancecottage
- Chapter 1Uploaded byAshwani Kumar Pritam
- US Federal Reserve: h6Uploaded byThe Fed
- money question.pdfUploaded bygopal
- US Federal Reserve: h6Uploaded byThe Fed
- Inflation and CRRUploaded byshashank1398
- Blondie's Freegold SummaryUploaded byrmullis
- US Federal Reserve: 790427confcallUploaded byThe Fed
- lecture2.pdfUploaded byselsel139
- Oliver Wyman_State of Financial Services Industry 2014Uploaded bykhalid.n.ali818
- 828.pdfUploaded byFouad Bin Amin
- money and bankingUploaded byShikha Sharma

- Trade, Unemployment and InequalityUploaded byJorge Rojas-Vallejos
- Soluciones Ejercicios de Macro 1Uploaded byJorge Rojas-Vallejos
- Happiness and Clean AirUploaded byJorge Rojas-Vallejos
- Notes on EconometricsUploaded byJorge Rojas-Vallejos
- Macroeconomic Theory NotesUploaded byJorge Rojas-Vallejos
- OLS estimators EconometricsUploaded byJorge Rojas-Vallejos
- Soluciones Set 1 Macro 1Uploaded byJorge Rojas-Vallejos
- General Equilibrium and Welfare EconomicsUploaded byJorge Rojas-Vallejos
- Auctions, best responses, reactions functions, Nash EquilibriaUploaded byJorge Rojas-Vallejos
- Economic GrowthUploaded byJorge Rojas-Vallejos
- Turbulence characteristics of a FluidUploaded byJorge Rojas-Vallejos
- The Inflation Tax in RBC: A revisionUploaded byJorge Rojas-Vallejos
- Demanda, Oferta y MercadoUploaded byJorge Rojas-Vallejos
- Impact of Income Distribution on Economic Growth, Rojas and KhorUploaded byJorge Rojas-Vallejos
- Lógica y Teoría de Conjuntos.Uploaded byJorge Rojas-Vallejos
- Ejercicios de MacroeconomíaUploaded byJorge Rojas-Vallejos

- Problem Set 2Uploaded bySachin Batwani
- calvo.pdfUploaded byJR
- Public Economics and Public AdministrationUploaded byNoah Mzyece Dhlamini
- OECD AnalysisUploaded bytamhieu
- 301 March 16 2012 SolutionsUploaded byamrith vardhan
- The Determinants of Growth - Nicholas SternUploaded byJermaine Ricketts
- AirbusUploaded byTapojyotee Banerjee
- Perfect Competition Lecture NotesUploaded byVlad Guzunov
- dis_rna_13Uploaded bySharath T R Kumar
- Macro Review IIIUploaded byAnonymous K8b1TFPyZ
- Ch06 - Perfectly Competitive MarketsUploaded byQuinnee Vallejos
- industrial-development.pdfUploaded byVivek Sanson
- Long Wave TheoriesUploaded bydidoltanev
- Assignment 3Uploaded byarafat
- Kirman - Demand Theory and General Equilibrium-From Explanation to Introspection, A Journey Down the Wrong RoadUploaded byJuanKg
- Midterm 2 With SolutionsUploaded byNikoleta Trudov
- MBA WBUT SyllabusUploaded byVinod Dhoundiyal
- Factor Price EqualisationUploaded byaghamc
- supply demand lessonUploaded byapi-239090309
- Beaver, W 1968. the Information Content of Annual Earnings AnnouncementsUploaded bygagakatalaga
- BEC 111 Principles of Micro Economics ModuleUploaded byKristine Collins Llorin Yambao
- Perfect competition in marketUploaded byWaqas Abbas
- Mathematical Model of Islamic EconomyUploaded bysalmanahmed_hyd
- Economic Instructor ManualUploaded byclbrack
- -Commodity-Markets-Project.docUploaded bymaitree sanghani
- Chapter 1 Lecture NotesUploaded byRachel Freeman
- Shapiro (1997)Uploaded byAndres Quiñones
- Funeco 4 Equi MdoUploaded byMilagros Rodríguez Alcántara
- Expectations and Exchange Rate DynamicsUploaded bynikitas666
- 4Uploaded byJaeDukAndrewSeo