CHAPTER 22
Quick Check
1. a. False The official deficit is a nominal number.
2. First, even a temporary deficit leads to an increase in the national debt, and therefore to higher
3. a. Interest payments are 10% of GDP, so the primary surplus is 10%-4%=6%.
b. Real interest payments are (10%-7%)*100%=3% of GDP. So the inflation-adjusted
c. Output is two percent lower its natural level. Using the rule of thumb in the text, the
d. The change in the debt to GDP ratio = (3%-2%)*100% – 6% = -5%. The debt to GDP
4. a. If money growth = 25%, 50%, 75%, seignorage=162.5, 325, 487.5.
b. In the medium run, if money growth = 25%, 50%, 75%, seignorage=162.5, 200, 112.5.
Dig Deeper
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5. a. The new interest rate is 10%+10%=20%. So assuming that expected depreciation was
b. The real interest rate increases from 3% to 17%. The high real interest rate is likely to
c. The official deficit increases from 4% to 14% of GDP. The inflation-adjusted deficit
d. In the first year, the change in the debt ratio = (14%-0%)*100%-6%=7%. It goes up
6. a. The IS curve shifts right. Output rises. The government finances the extra spending by
b. The IS curve shifts right, but by less than the amount in part (a). In fact, the IS curve will
c-d. The results are the same as in part (b). If Ricardian equivalence holds, the financing
e. Statement (i) is false. Statement (ii) is true.
Explore Further
7. a. Since the real interest rate equals the growth rate, the annual change in the debt to GDP
e. After 5 years, the debt-to-GDP ratio will be 60%. A primary surplus of 2% of GDP for
f. If the growth rate declines, the debt-to-GDP ratio will tend to grow more quickly, so a
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g. The policy in part (e) is probably more dangerous. First, this policy relies on the promise
8. a. Over 2014, (the latest years as this is written), the ratio of debt-to-GDP remained
b. The primary deficit in 2014 was 2.0%. The ratio of debt-to-GDP can fall even if there is
c. The missing term is (r-g) times the ratio of debt to GDP. The latter value is 105% (think
d. Japan has by far the largest debt-to-GDP ratio, over 200% in2014. The lowest debt-to-
CHAPTER 23
Quick Check
1. a. False. Seignorage profits are typically very small and not sufficient to warrant the costs
b. False. The Fed is also charged with growing the economy and job creation.
g. True or uncertain. The Taylor rule uses both inflation and unemployment to help
h. False. Zero bound did not emerge as an issue until after the financial crisis of the late
i. True
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2. a. In the medium run equilibrium, the real interest rate is at rn. This is the real interest rate
b. The right hand side of the money demand equilibrium will not change. Thus the left-hand
c. The right-hand side of the money market equilibrium will now grow at 3% per year. Thus
d. In the part of Figure 23-1 before 1995, money growth appears to exceed inflation (price
e. (i) This would reduce average cash holdings – easier to get cash when needed
f. Between 1980 and 2015, cash holdings rose by a factor of 10 and nominal GDP rose only
3. a. The two version differ in that in first version the inflation rate changes between last
of the
b. The central bank would set the nominal interest rate and thus the real interest rate
´π
c. You can see if
´π
= π* then the unemployment rate is always at the natural rate. The
central bank’s task is very easy.
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d. You can see if πe = πt-1then if inflation was higher than target last period, expected
e. Credibility means people always believe that expected inflation will be target inflation.
f. This is not likely in practice. Shocks will drive actual inflation from target. It is unlikely
g. It will make it harder for central bank to set interest rates. Changes in the natural rate will
4. a. The nominal interest rate is ($100-$PB)/PB
b. The real interest rate is [($100/P(+1))-($PB/P))] / ($PB/P))
c. The payment on the bill will rise to $110. The real interest rate will simply be the
d. It depends on your sensitivity to risk and your perception of the variation of actual
The non-indexed bond has some risk. If inflation is lower than expected, its real return
In addition, you might disagree with the market on the level of expected inflation. If you
5. a. The Fed was increasing the price (lowering the yield) on these securities by purchasing
b. The Fed was trying to raise the price (lower the yield) on these securities. In terms of
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c. You would expect to see long-term bond yields rise.
6. a. The minimum down payment is 20% of the home’s value or $60,000.
b. If the loan-to-value maximum is reduced, this increases the down payment. We would
c. Canadian home prices have continued to rise and the rate of increase was not slowing up
Dig Deeper
7. a. i. r=4%-0%=4%; ii. r=14%-10%=4%
c. Given the deductibility of nominal mortgage interest payments, inflation is good for
8. Discussion question.
Explore Further
9. The Bank of Japan and the Federal Reserve all spent considerable time with their policy rate of
10. Answers will depend upon current Fed policy.
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