2023 AP Macroeconomics FRQ Set 1 #2 (Phillips Curve, Ample Reserves, FOREX)

 2023 AP Macroeconomics FRQ Set 1 #2

(From the Ample Reserves Cheat Sheet)

2. The economy of Norlandia is in short-run equilibrium with an actual inflation rate that is currently higher than the expected inflation rate.

This implies that the economy is in an inflationary gap.

Look at this graph from the Phillips curve cheat sheet.

Notice that expected inflation is the same as full employment

If the inflation rate is greater than expected inflation we must have an inflationary gap.

A) Draw a correctly labeled graph (CLG) of the short run and long run Phillips curve. Label the current short run equilibrium point as X.

B) The banking system in Norlandia has ample reserves. Identify a specific monetary policy action that the central bank of Norlandia would take to bring the inflation rate closer to the expected rate of inflation.

Ample Reserves used to decrease the Price Level (PL) Inflation

would need to be contractionary.

Contractionary Monetary Policy with Ample Reserves is 

Increasing the Administered Interest Rate (AIR)

or

Increasing the Interest on Reserve Balances (IORB)

A specific monetary policy to lower inflation toward the expected inflation rate 

is to increase the (AIR) Administered Interest Rate

C) Based solely on the effect of the monetary policy action identified in part (b) on interest rates in Norlandia, will there be an increase, decrease or no change in the flow of international capital into Norlandia? Explain.

We should understand that foreign capital (money) is always looking for higher rates of return.

Higher interest rates in Norlandia will attract more/increase foreign capital as these investors want to put their money into Norlandia to make higher profits on the higher interest rates paid in Norlandia banks.

(we are speaking about people putting their money into Norlandia banks 

and earning a higher interest rate on their savings/capital)

D) Based on the answer in part (c), what will happen to international value of Norlandia's currency? Explain.

For foreign capital to flow into Norlandia's banks and get the higher interest rates it first must be converted into Norlandia dollars as Norlandia banks only accept Norlandian currency.

If people are buying more Norlandian currency 

then the supply of Norlandian currency in the FOREX is decreasing/shifting leftward

this will cause the value of Norlandian currency to appreciate.

 2019 AP Macro (Set 1) FRQ#3

Watch me answer it here

https://youtu.be/aG6B62m3eX0

(a.) Draw a CLG of the short run and long run Phillips curve. Label the current short-run equilibrium as Point X and plot the values on the graph.

(b) Is the actual inflation rate greater, less than or equal to the Expected Inflation Rate of 3%.

Less than.

The economy is currencty in a recession and has a lower PL and greater unemployment rate than the Expected inflation rate and NRU.

(c) Assume loans were made taking into account the expected rate of inflation at 3%, will lenders (creditors, bankers) be better off, worse off after they realize the actual inflation rate identified in part B? Explain.

Better off as the actual inflation rate is less than the expected rate.

Bankers must take into account the inflation rate. Why?

Suppose you make a loan to someone with an interest rate of 3%. This is the nominal rate you have charged them and actual inflation turns out to be 3%. 

Stupid, Stupid, Stupid

{{Nominal - INflation = Real}}

If you charge then 3% and the Inflation rate is 3% then you have made 0 real dollars

Remember inflation implies that the price of everything increased by 3%, 

you made 3% on your loan but the price of everything increased by 3%.

If you had charges 5% and the inflation rate was 3% then you would have made 2% on your money.

If you charged 3% and the inflation rate was 1%, then you earned 2% on your loan and this is what we have in the problem above. The actual rate is less than the expected rate of 3% and therefore the banker wins.

(d) Based on the relationshipbetween the actual and the expected, what will happen to the natural rate of unemployment in the long-run?

What we know is that in the long-run we always return to the LR rate of unemployment at 4%.

The only time the college board has tested the NRU actually changing was 1 year when they had unemployment benefits increasing. This caused more people to choose to stay unemployed and therefore the NRU increased as the LRPC shifted right.

In the situation above (in the long-run) wages would fall, input prices would fall and the SRPC would shift leftward taking us back to fullemployment at a lower price level.

but the NRU would remain unaffected.

(Think Classical view)

2019 Macro FRQ #2

2019 Macro FRQ #2

Actual inflation is less than the Expected Inflation

As the actual rate of inflation is below the expected rate lenders are better off.

Think of it like this.

Your a banker you need 5% profit and you expect inflation to be 3% this year, 

If you just charged 5% at the end of the year the 3% inflation 

would have decreased what you gained on the loan to 2%

5% Nominal rate - 3% Inflation rate = 2% Real rate

so,

If you know you need to make 5% and inflation is expected to be 3% 

you make the rate of interest on your loan to be 8%.

8% nominal rate - 3% Inflation rate = 5% Real rate

as,

The actual inflation rate was less than the 3% expected rate

lenders would be better off as they make more profit 

due to lower actual inflation rates.

The natural rate of unemployment is not affected by by changes in the price level in the LR.

Remember that the NRU includes frictional and structural

Cyclical is not included into the NRU 

Cyclical has to do with recessions and inflationary scenarios

So changes due to AD/AS changes do not effect the NRU

What would affect the LRPC

1) Increased Unemployment Benefits attract citizens to stay unemployed longer shifting the LRPC to the right (Higher Natural Rate of Unemployment)

2) Higher Minimum wage rates - shifts the LRPC to the right

3) Frictional Unemployment increases - LRPC shifts right

4) Structural Unemployment Increases - due to better tech making jobs obsolete. LRPC shifts right.

5) Better ways for unemployed and employers to meet would shift the LRPC left reducing unemployment in the long run.

2013 Macroeconomics FRQ #3b (Expected Inflation)

Again, workers recognise that the PL is increasing and demand higher wages. They are able to get higher wages because the economy is overproducing and labor is in high demand. Higher wages cause business to decrease production (SRAS) shifts left. A shifting of the SRAS curve creates a corresponding shifting of the SRPC to the right. In the Long Run the  PL increases and the economy returns to the 6% natural rate of unemployment (NRU).

NIR = RIR + Expected Inflation (Not sure about numbers used, will fix tomorrow as it is late for me)

(Hat tip Ross & Meek)