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n Answers to Textbook Problems
1. A reduction in the home money demand causes interest rates in the home country to fall from Rh,1 to
2. A fall in a country’s population would reduce money demand, all else being equal, since a smaller
population would undertake fewer transactions and thus demand less money. This effect would
probably be more pronounced if the fall in the population were due to a fall in the number of
3. Equation 15-4 is Ms/P L(R, Y). The velocity of money, V Y/(M/P). Thus, when there is equilibrium
in the money market such that money demand equals money supply, V Y/L(R, Y). When R increases,
4. An increase in domestic real GNP will cause domestic real money demand to rise. This will cause
© 2012 Pearson Education, Inc. Publishing as Addison-Wesley
Chapter 15 Money, Interest Rates, and Exchange Rates 77
5. Just as money simplifies economic calculations within a country, use of a vehicle currency for
international transactions reduces calculation costs. More importantly, the more currencies used in
6. Currency reforms are often instituted in conjunction with other policies which attempt to bring down
the rate of inflation. There may be a psychological effect of introducing a new currency at the moment
7. The interest rate at the beginning and at the end of this experiment are equal. The ratio of money to
prices (the level of real balances) must be higher when full employment is restored than in the initial
state where there is unemployment: the money-market equilibrium condition can be satisfied only
8. The 1984–1985 money supply growth rate was 12.4% in the United States (100% (641.0 –570.3)/
570.3) and 334.8% in Brazil (100% (106.1 – 24.4)/24.4). The inflation rate in the United States
© 2012 Pearson Education, Inc. Publishing as Addison-Wesley
Chapter 15 Money, Interest Rates, and Exchange Rates 78
9. Velocity is defined as real income divided by real balances or, equivalently, nominal income divided
10. If an increase in the money supply induces an increase in real output in the short run, then the short-run
decrease in the real interest rate will not be as pronounced as it was without the increase in real output.
In the diagram below, the money supply rises from Ms,1 to Ms,2. This causes real output to rise from Y1
11. As the interest rate falls, people prefer to hold more cash and fewer financial assets. If interest rates
were to fall below zero, people would strictly prefer cash to financial assets as the zero return on cash
12. One clear complication that a zero interest rate introduces is that the central bank is “out of ammunition.”
It literally cannot reduce interest rates any further and thus may struggle to respond to additional shocks
that hit the economy over time. The central bank is still not completely powerless, it can print more
© 2012 Pearson Education, Inc. Publishing as Addison-Wesley
Chapter 15 Money, Interest Rates, and Exchange Rates 79
13. a. If money adjusts automatically to changes in the price level, then any number of combinations of
b. Yes, a rule such as this one would help anchor the price level and imply there is no longer an
c. A one-time permanent unexpected fall in “u” would imply that R would have to fall until prices
have a chance to rise and balance out the equation. As prices rise, R would return to its initial
© 2012 Pearson Education, Inc. Publishing as Addison-Wesley
