L4 MP

Question 1

What should we control- i or M?

Answer 1

Does not matter as long as no demand uncertainty. Otherwise could be affected by

Unexpected price shocks
Tech developments changing the structure of money demand
Changes in riskiness of assets

Banks don’t just sit back, they actively choose to respond to changes in Y SO best to fix i, which is done be setting a desired real interest rate, R

Question 2

How do we know what kind of ‘neutral value’ for R we get? Ie which model do we use

Answer 2

The classical model, where savings and investment determined by the supply side in the long run

Question 3

What does the ZLB imply?

Answer 3

That nominal rates on bonds can not be negative as the otherwise cash would dominate bonds not only for transactions but also as an asset

Question 4

DEF: liquidity trap

Answer 4

The impossibility of reducing i below zero

Question 5

The lower the inflation, the _ the floor on r

Answer 5

Higher

Think of i = r + pi
And pi being negative

Question 6

What are the implications of the ZLB for the MP curve?

And what about the LM curve? (Think ito changes in liquidity demand due to changes in Y)

Answer 6

MP cannot go below the ZLM

For the LM curve
Holding Ms constant, r may not be sensitive to Y. As Y falls money demand will fall but not by much, once the money supply is sufficiently high.
This places a floor on LM at -pi (expt)