CHAPTER 5
Quick Check
1. a. True.
g. False. The real money supply falls when the nominal money supply is constant and the
2. a. Y=[1/(1-c1)][c0–c1T+I+G]
b. Y=[1/(1-c1–b1)][c0–c1T+b0–b2i+G]
c. You simply replace the interest rate from the expression in (b) with its policy value i bar., Y=[1/
3. a. The IS curve shifts left. Output falls at the same interest rate. Investment, which depends
b. From the answer to 2(b), Y=[1/(1-c1–b1)] [c0 – c1 T+ b0–b2i bar + G]
c. I= b0+b1Y–b2i=b0+ b1 [1/(1-c1–b1)] [c0 – c1 T+ b0–b2i bar + G]- b2 I bar
d. From part (b), the equilibrium level of income is Y=[1/(1-c1–b1)] [c0 – c1 T+ b0–b2i bar +
4. a. The real money supply is on the left hand side of the equation
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5. a. Y=C+I+G=200+.25(Y-200)+150+.25Y-1000i+250
b. Substitute the interest rate of 5% (numerical value .05) into Y = 1100 – 2000 x (.05) =
c Now substitute both equilibrium income of 1000 and the interest rate of 5% into the right
d. C=400; I=350; G=250; C+I+G=1000
e. Y=1040; C=410; I=380. The reduction in the interest rate increases output consumption
f At the initial interest rate of 5%, Y equals 1300 when G is increased to 400. A fiscal
Dig Deeper
6. Firms deciding how to use their own funds will compare the return on bonds to the return on
7. a. The reduction in T shifts the IS curve to the right. The decrease in interest rates shifts the
b. The Clinton-Greenspan policy mix was (loosely) contractionary fiscal policy (IS left) and
c. In 2001, there was a recession, which was triggered by a fall in investment spending
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8. a. The central bank keeps the interest rate constant. Fiscal policy is expansionary as either
b. The central bank will cut interest rates as the fiscal authorities either reduce G or raise T
9. a. The IS curve shifts left. The value of the parameter c0 falls. Output falls.
b. The level of consumption falls with the fall in output. There is a lower level of output
Finally, we analyze the level of saving. The level of savings at the same income would
Explore Further
10. a. The fall in G and the increase in T shift the IS curve to the left. If the Federal Reserve did
b. Receipts rose, outlays fell, and the budget deficit fell.
c. On September 4, 1992, the FOMC reduced the intended federal funds rate by 25 basis
points. Subsequent changes in federal funds rate over the period 1993-2000 are given
below.
Changes in the Intended Federal Funds Rate
September 4, 1992 3 March 25, 1997 5.5
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d. In real terms, investment was 11.9% of GDP in 1992 and increased every year over the
e. Over the period 1993-2000, the average annual growth rate of GDP per person was
11. a. Growth was negative in 2001:I and 2001:III.
b. Investment had a bigger percentage change, and unlike consumption, growth in
c. Investment had a substantially larger decline in its contribution to growth in 2000 and
d. Investment fell in the last two quarters of 2001, but began growing again in the first
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