6. The Fisher effect and the cost of unexpected inflationSuppose t.pdf

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6. The Fisher effect and the cost of unexpected inflation Suppose the nominal interest rate on savings accounts is 9% per year, and both actual and expected inflation are equal to 3%. Complete the first row of the table by filling in the expected real interest rate and the actual real interest rate before any change in the money supply. Now suppose the Fed unexpectedly increases the growth rate of the money supply, causing the inflation rate to rise unexpectedly from 3% to 6% per year. Complete the second row of the table by filling in the expected and actual real interest rates on savings accounts immediately after the increase in the money supply (MS). The unanticipated change in inflation arbitrarily harms(banks/depositors). Now consider the long-run impact of the change in money growth and inflation. According to the Fisher effect, as expectations adjust to the new, higher inflation rate, the nominal interest rate will (rise/fall) to_____%per year. Time PeriodNominal Interest RateExpected InflationActual InflationExpected Real Interest RateActual Real Interest Rate(Percent)(Percent)(Percent)(Percent)(Percent)Before increase in MS933 ______ _______Immediately after increase in MS936 ______ ________ Solution we know that fishers equation of inflation measures the actual and nominal rate of interest rate. Irving fisher explains this is based on the formula: real interest rate= nominal interest rate-actual or expected rate of inflation the unanticipated change in inflation arbitrarily harms- Depositors Nominal interest rate will rise 12% per yeartime periodsexpected real interest rateactual real interest ratebefore increase in money supply9-3=6%9-3=6%immediatly after increase in MS9- 3=6%9-6=3%.

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What recent and past actions have Canada and the US taken to counteract their exchange rates with the economy in such distress over the past 10 years? Solution Since 2007, the world has experienced a period of severe financial stress, not seen since the time of the Great Depression. This crisis started with the collapse of the subprime residential mortgage market in the United States and spread to the rest of the world through exposure to U.S. real estate assets, often in the form of complex financial derivatives, and a collapse in global trade. Many countries were significantly affected by these adverse shocks, causing systemic banking crises in a number of countries, despite extraordinary policy interventions. Systemic banking crises are disruptive events not only to financial systems but to the economy as a whole. Such crises are not specific to the recent past or specific countries – almost no country has avoided the experience and some have had multiple banking crises. While the banking crises of the past have differed in terms of underlying causes, triggers, and economic impact, they share many commonalities. Banking crises are often preceded by prolonged periods of high credit growth and are often associated with large imbalances in the balance sheets of the private sector, such as maturity mismatches or exchange rate risk, that ultimately translate into credit risk for the banking sector. Crisis management starts with the containment of liquidity pressures through liquidity support, guarantees on bank liabilities, deposit freezes, or bank holidays. This containment phase is followed by a resolution phase during which typically a broad range of measures (such as capital injections, asset purchases, and guarantees) are taken to restructure banks and reignite economic growth. It is intrinsically difficult to compare the success of crisis resolution policies given differences across countries and time in the size of the initial shock to the financial system, the size of the financial system, the quality of institutions, and the intensity and scope of policy interventions. With this caveat we now compare policy responses during the recent crisis episode with those of the past. The policy responses during the 2007-2009 crises episodes were broadly similar to those used in the past. First, liquidity pressures were contained through liquidity support and guarantees on bank liabilities. Like the crises of the past, during which bank holidays and deposit freezes have rarely been used as containment policies, we have no records of the use of bank holidays during the recent wave of crises, while a deposit freeze was used only in the case of Latvia for deposits in Parex Bank. On the resolution side, a wide array of instruments was used this time, including asset purchases, asset guarantees, and equity injections. All these measures have been used in the past, but this time around they seem to have been put in place quicker (for detailed informatio.

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5. 5i thterest Rates: Macroeconomic Factors that Influence Interest Rate Levels Macroeconomic factors have an important effect on both the general ievel of interest rates and the shape of the yield curve. These primary factors are: Federal Feserve policy, the federal budget deficit or surplus, international facters like the forelgn trade bolance and interest rates abroad, and the level of business activity. The Federal Reserve Board centrols the maney supply. To stimulate the economy, the Fed the money supply. The initial effect would be to cause short-term rates to decline; however, a money supply might lead to an increase in expected future inflation, which would cause long-term rates to rise even as short-term rates fell, The revions is true when the fed the money supply. If the government spends more than it takes in as taxes, it runs a , which must be covered by addibonal borrowing or by printing maney. If the government borrows money, this the demand for funds and interest rates. If the government prints money, the resuit wall be inflation, which will the levei of interest rates. rates. So, the larger the federal , other things held constant, the If U.S. buakeises and individuals buy more goods from abroad than they sell (more imports than exports), the U.S. is running a foreign trade which must be financed This gernerally means that the U.S; becrows frem nations wikh expert The larger the trade The hugher the tendency to borrow, so U.S. interest rates become highly dependent on interest rate levels abroad. Consequenty, this interdepencency the fed's ability to use monetary poticy to control U.S. economic activity. Dusiness conditions infuence interest rates, During a , the demand for money and the infation rate tend to fall and the fed tends to the moner supply to stimulate the economy. As a resuit, there is a tendency for interest rates to decine during During , short-term rates decline more shacply than long-term rates because (1) the Fed operates main/y in the short- term sectoc, so the Fef's intervention has the strongest effect there; (2) Long-term rates reflect the average expected infation rate over the neat 20 to 30 years and this expectation doesn t change much due to the level of cument infation. So, short-term rates are volatile than long-term rates..

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Question 1: Response 1: Development inside and out effects the entire country's economy. It impacts the managing body, regardless the clearly irrelevant subtleties in the average person's dependably life. Both a conditions and clear deferred results of how the economy is getting along, swelling has the two its fans and spoilers. Distinctive envisions that particular degrees of swelling are helpful for a prospering economy, yet that progressively critical rates raise concerns. It can degrade the money basically and, at logically lamentable, has been a key part to subsidences. Swelling, as referenced, is the rate a worth ascensions, and fundamentally how much the dollar is worth at a given moment concerning checking. The idea behind swelling being an impact for good in the economy is that a reasonable enough rate can nudge financial movement without debasing the money so much that it ends up being basically vain (Kohn, 2006). Swelling can in like manner falter from asset for asset. Subordinate upon the season, the expense of gas could go up independently from with everything considered headway as it routinely does as summer moves close. In reality, there is even a term - focus improvement - for swelling that parts in everything except for sustenance and imperativeness (gas and oil), as these regions have separate factors that add to them. There are a wide degree of sorts of swelling, subordinate upon what remarkable is being viewed comparatively as what the development rate truly is by all accounts. For example, what happens if the swelling rate is well over the Fed's normal goal? At a higher rate, yet still in the single digits, that is known as walking swelling. It is seen as concerning yet sensible (Ball, 2006). Swelling is generally depicted reliant on its rate and causes. By and large, Inflation happens in an economy when vitality for thing and experiences outmaneuvers the supply of yield. in this manner, clarifications behind Inflation have different sides, the intrigue side and supply side. The widely inclusive activity of hazard premiums in driving enlargement pay over the scope of advancing years is dependable with secured budgetary improvement and inside and out oblige cash related procedure events in the moved economies. The degree for further fitting budgetary enabling seen with money related stars seems to have declined amidst the enough low advance charges and gigantic monetary records of national banks (Bodie, 2016). In relentless time, the correspondence of perils has wound up being constantly phenomenal, the general point of view has lit up, and money related conditions have engaged on net. With the work superstar proceeding to reinforce, and GDP improvement expected to keep up a vital good ways from back in the consequent quarter, it likely will be fitting soon to change the affiliation supports rate. Likewise, if the economy propels as shown by the SEP concentrate way, the affiliation supports rate will probably app ...

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In a recessionary and deflationary framework, the discretionary monetary policy cannot be optimal when the interest rate is already near zero and cannot decrease anymore. Indeed, when the Zero Lower Bound is binding, a negative demand shock implies a decrease in the current economic activity level and deflationary tensions, which cannot be avoided by monetary policy as the nominal interest rate can no longer decrease. The economic literature has then often recommended to target an inflation rate sufficiently above zero in order to avoid the dangers of this Zero Lower Bound (ZLB) constraint. On the contrary, provided the ZLB is not binding, monetary policy can efficiently contribute to the stabilization of economic activity and inflation in case of demand shocks. The variation in interest rates is then all the more accentuated as interest rate smoothing is a more negligible goal for the central bank. The contribution of our paper is to provide a clear analytical New-Keynesian framework sustaining these results. Besides, our analytical modelling also shows that even if the ZLB is currently not binding, the central bank should take into account the dangers of a potential future binding ZLB. Indeed, the interest rate should be decreased the fastest as a negative demand shock and the possibility to reach the ZLB is anticipated for a nearest future period. Our paper demonstrates the necessity of such a ‘pre-emptive’ active monetary policy even in a discretionary framework, which has the advantage to be time-consistent and to be in conformity with the empirical practices of independent central banks. We don’t have to make the strong hypothesis of a commitment monetary policy intended to affect private agents’ expectations in order to demonstrate the optimality of such a pre-emptive monetary policy.

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