True or False (explain):
1. Imagine an economy where velocity is constant. The money supply is growing by 10% per year, while the growth rate of real GDP is 5% per year. The nominal rate of interest is 8%. The real interest rate must be 4%.
2. Unanticipated deflation redistributes income and wealth from borrowers to lenders.
3. Suppose there are two types of investments, business investments Ib(r), and real estate investments Ir(r). The gov't decides to subsidize business investments (but not real estate investments). If private savings, Sp, is perfectly interest inelastic (i.e. it's unaffected by the real interest rate), then this subsidy will cause both real estate and business investments to increase.
Using the neoclassical model, predict what would happen to: 1) real wage, 2) employment, 3) GDP, 4) the interest rate, 5) investment and 6) the price level. If some things do not change, you must explain why.
1. There is a permanent increase in the nominal supply of money.
2. The Bush administration cuts income taxes
3. The gov't announces that, because of unseasonably cold weather, there has been a decline in consumption. Income has also decreased, due to dislocations in supply. However, consumption has been falling faster than income. True or False: The neoclassical model predicts that interest rates should increase.