Problem Set 9

ECONOMICS 101B: FALL 2006: PROBLEM SET 9

 Due December 7, 2006

Short Answers:

1. What is the “Lucas critique”? How would the Lucas critique suggest that you should design a policy to try to reduce inflation from 10% per year down to 2% per year?

2. What is "dynamic inconsistency"? Why does dynamic inconsistency strengthen the case for having policy rules rather than leaving economic policy to the discretion of authorities?

3. What can you say about under what circumstances the Federal Reserve should focus on keeping the interest rate as opposed to the money stock stable?

4. Why do economists today tend to believe that monetary policy is superior to discretionary fiscal policy as a stabilization policy tool? In what circumstances that you can imagine would this belief be reversed?

5. Suppose that the level of investment spending does not depend at all on the interest rate. Does this mean that the IS curve is vertical? How then can central bank changes in the real interest rate effect the level of real GDP in the sticky-price model?

6. Briefly, why was the Great Depression so great?

7. Briefly, why should we (or should we not) worry about the fact that the U.S. is running a very large trade deficit?

8. Briefly, what conclusions can we reach from the low level today of U.S. long-term interest rates?