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Practice Questions: Set 6. Money and Prices Lecture Dates: Jan. 26th and 28th i). Suppose that the money growth rate in an economy increases from 10% to 20%, and that, as a result, inflation increases from 10% to 20%, and real output falls by 7%. a) Is money neutral in this economy? Explain. b) Is money superneutral in this economy? Explain. (Hint: “There’s not enough information to say” is a possible answer to questions like this one. If that is your answer, you should tell me what additional piece(s) of information you would need in order to answer the question and why this information is needed.)

ii) Is money likely superneutral in the real world? Discuss the evidence where possible. (Hint: a good answer should cover all of the cases (e.g. extreme vs. moderate money growth rates).

iii) Is money liekly neutral in the real world? Discuss the evidence where possible. (Hint: a good answer should cover all of the cases (e.g. short vs. long run neutrality). iv) Give an example where monetary neutrality appears to hold in the real world. Explain.

v) The Quantity Equation and Quantity Theory of Money. a) Write out the Quantity Equation of Money. Explain what the equation says, and why it must be true. b) What assumption generates the Quantity Theory from the Quantity Equation? What result does this assumption generate? Explain. c) What additional assumption generates the prediction of monetary neutrality? Explain.


vi) Explain why, from a theoretical perspective) monetary neutrality makes sense. (Hint: You can use the Quantity Theory here as part of the answer, but you should be able to say more. Essentially, you should provide an argument as to why it is reasonable to think that people don’t change their real economic decisions when the money supply changes).

vii) Explain why, from a theoretical perspective, monetary superneutrality seems unlikely to be true (at least for extreme money growth rates).

viii) Define hyperinflation. (I forgot to give an explicit definition in class, but you should know the term, and it’s not too hard to figure out (or look up) a definition).

ix) Effects of hyperinflation: a) Explain why the monetary system breaks down during hyperinflationary episodes. b) Explain why the break down in the monetary system has disastrous effects on the real economy.

x) Why is the evidence from hyperinflationary periods more convincing than evidence during more normal periods? Explain.

xi) Suppose we observe that sees increases in ice cream sales occur at the same time as increases in shark attacks. Explain why the consultant should not conclude from this that increases in ice cream sales cause increases in shark attacks. (Hint: Give the general answer, along with some speculation about how the different possibilities might work.)

xii) Suppose a consultant for a firm sees that increases in the advertising budget occur at the same time as increases in revenue. Explain why the consultant should not conclude from this that increases in the advertising budget cause increases in revenue. (Hint: Give the general answer, along with some speculation about how the different possibilities might work.)


xiii) Suppose we see that increases in the money supply occur at the same time as increases in real output. Explain why we cannot conclude from this that increases in the money supply cause increases in real output. Why is this a serious problem for empirical work in monetary macroeconomics?


Testing