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Help with Macroeconomics Question

post #1 of 3
7/8/09 at 11:07pm
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Scenario: Government and central bank economists determine that the U.S. has a potential (full employment) GDP of $13 trillion. However, actual GDP is projected to be $12 trillion. The Fed has mandated that banks keep 5% of their deposits in reserve. Regarding the equation of exchange, MV=PQ Fed policymakers believe that V= 3. The Fed economists believe that they need to deal the macroeconomic situation by changing the money supply. How can they affect the money supply and how much money do they need to inject or withdraw in order to solve the economic problem? Solution: M*3=12 trillion M=12 trillion/3 M=4 M*3=13trillion M=13trillion/3 M=4.33 MV=PQ V=3 P=1 (assumption for short-run - constant price level) Q*=13 Q=12 M=PQ/V=1"¢12/3=4.00 M*=PQ*/V=1"¢13/3≈4.33 ΔM=M*-M=4.33-4.00=+0.33 ΔM% = (M*-M)/M = M*/M - 1=13/12 -1=1/12≈0.083≈+8.3% So assuming constant velocity and fixed price level - money supply (high powered money) should be increased for ≈ +8.3% M - money supply MB - monetary base MM - money multiplier RR - reserve requirement M=MB"¢MM Assuming no excess reserves and no currency drains: MM=1/RR=1/5%=1/0.05=20 (1+ΔM%)=(1+ΔMB%)"¢(1+ΔMM%) ΔM%=+8.3% 1+8.3%=(1+ΔMB%)"¢(1+ΔMM%) 1.083=(1+ΔMB%)"¢(1+ΔMM%) Thus, or the monetary base should be increased for ≈ +8.3% [open-market operations or discount loans] Or money multiplier should be increased for ≈ +8.3% through reserve requirement decrease to 4.6% from 5% 1+ΔMM% ≈ 20+8.3% ≈ 21.67 MM=1/RR=21.67 ⇒ RR=1/21.67≈0.046 ≈ 4.6% Second part Given the scenario in the previous question, how might the fiscal authorities deal with the problem? By how much would they need to change government spending in order to get the economy to full employment? This is where I'm stuck....
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post #2 of 3
7/9/09 at 9:24pm
Dude, are you studying economics using a 1965 edition of Samuelson?
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post #3 of 3
7/9/09 at 9:46pm
Interesting and EXTREMELY relevant question. It should be clear than more money spent means higher employment--in theory. However, there is an issue that has to do with too much being spent and crowding out the regular consumer. You may not have to worry about this though. A simple solution: You can figure out the unemployment rate with Okun's Law (given the output gap) then use this UR to estimate how much the government needs to spend (using a similar law) that will bring it back to full employment.
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