Prof. Bryan Caplan

Econ 918

Spring, 1998

HW#2 (due in class, week 8)

(Please type your answers to all questions, including any mathematics. Each answer should be approximately 1-1.5 pages in length, double-spaced).

1. Re-solve the simple RE model presented in class, with the following modifications:

a. (Easy) Determine the impact of a money-targeting rule, so that . You may simply plug into the solutions for pt and yt to get the answer.

b. (Harder - partial credit awarded!) Determine the impact of an interest-rate targeting rule, so that . Hint: Expect the nominal interest rate to equal the rate of money supply growth. To get started:

i. Plug the constant value of i into the Fisher equation.

ii. Substitute the Fisher equation into the IS equation.

iii. Then conjecture .

iv. Plug this conjectured solution for money into the LM equation to get an equation for current prices, and take expectations of this equation to solve for the expectations terms.

v. Use all this info to solve for the implied values of , , and .

Does your answer make sense? Do these exercises suggest anything about the relative benefits of money and interest targeting?

2. Apply my discussion of the "demand for irrationality" to one puzzle of your choice. What is the implied willingness to pay for the irrational belief? Are the social costs of this belief greater than the private costs?

3. Develop an Austrian reply to one of my criticisms of ABC. How would I reply?

4. Which of the assumptions underlying the ABC discussed by Cowen is most damaging?

5. Take a position on the debate on the optimal rate of inflation, and briefly state your case. What are the best criticisms your defense would draw? How would you reply?