http://www.gmu.edu/departments/economics/bcaplan

Econ 816

Spring, 2000

**HW#2**

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**Part 1: Mathematical Problems**

1. Re-do the
Lucas islands model presented in the notes, assuming that the money supply is __constant__;
i.e., _{}. Intuitively explain
your results.

2. For the
Lucas islands model, solving the problem where monetary authorities target the *nominal
interest rate* is particularly difficult. You have to conjecture two equations:

_{} AND _{}.

Why do these equations make sense? Use basic monetary and RE principles to
rationalize them. *You do not need to solve the problem.*

3. Romer, problem 9.4.

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**Part 2: Analytical Problems**

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__TYPE__* succinct (1 page or less!)
answers to each of the following:*

1. When do deviations from "rational expectations in the aggregate" occur? When do severe instances of the "bias towards zero in aggregate perceptions" appear? Is there any common pattern that both deviations from RE share?

2. Agree or disagree: Caplan's "rational irrationality" analysis suggests that the rational expectations assumption probably applies in all macroeconomic models so long as they do not have a political component.

3. Pick a specific government policy that you think is inefficient. Which, if any, of Caplan's findings in "Systematically Biased Beliefs About Economics," would explain the existence of this policy? Do Caplan's findings make "special interest"/rent-seeking explanations of your example superfluous?