Saturday, November 22, 2008

Greg Mankiw's Blog: A Macroeconomic Puzzle

Greg Mankiw's Blog: A Macroeconomic Puzzle


Prof Mankiw's Question:

You observe an economy sinking in recession. As this occurs, real interest rates are rising, and the currency is strengthening. What shock, or set of shocks, could have caused these events?

The money market is same as any another market demand and supply. - Excess money supply people buy bond as result bond price rises and the interest rate falls. Excess money demand people sell bonds so bond price fall and the interest rate rises.

Expansionary monetary policy: Increase money supply – surplus and people buy bond so decrease interest rate. Contradictory monetary policy - decrease money supply, shortage of money and increase interest rate.

For example: the below is Australia Monterey policy adjustments interested rates(cash rates)in 1999.

Data: Reserve Bank Australia(RAB)
Q1) 5% to 6.25% , same time monetary bases from $29.7 billion to 28.2 billion year 2000.
Q2) 6.25% down to 4.25% same period base expansion was from $29.2 billion to $37.0 billion January 2001 to December 2001
Q3) 4.25% to 5.25 % same period base expansion was $35.0 billon to $ 38.8 billon year 2002 to 2003.

Interpreting the date Monterey policy adjustment point of view and the impact of the responds of the demand and supply for money on interest rates.

Answer:
A1) RBA reduced the monetary base, with demand for money either increasing over the period or remaining unchanged - contradictory monetary policy push interest upward.
A2) During this period RBA, increased the monetary based with demand money, this expansion in supply put downward pressured on interest rates- Expansionary monetary policy.
A 3) The demand money increased more rapidly then supply during this period, the result was in general Australian financial market liquidity was tighten sufficiently by the RBA to result of desired increased in the cash rate.