question 5 marks)
- Cooperative stabilization can help countries have a Öxed exchange rate regime and
avoid high ináation. - The existence of international currency traders makes the exchange rate determinate.
- Suppose we introduce money in the model with capital. The Tobin e§ect suggests
that an increase in the ináation rate will increase the stock of capital and consumption of
(c1; c2) by individuals. - Consider the three-period OLG model whereÖnancial intermediaries are subject to a
positive reserve requirement. A higher growth rate of money supply leads to a higher price
level. - (10 marks) Understanding the velocity of money and the quantity theory of money
in Australia. Economists measure the velocity of money as P Y =M, where P Y and M
are output (GDP) and money supply in nominal terms. The ratio P Y =M indicates the
frequency at which a unit of money is used to purchase Önal goods and services included
in nominal GDP. In this question, we explore how the velocity of money has changed in
Australia from 1975 to 2019 using money supply measured by M1 and M3. We then use
the empirical Öndings to examine if the quantity theory of money holds in Australia. Please
submit your data (keeping three decimal places) as an appendix to your assignment.
(a) Use data from Australian Bureau of Statistics to Önd nominal output P Y . In
particular, you can use data series 5206.0 (Table 3, Column CG) to Önd quarterly Gross
Domestic Product (P Y ).
(b) From the Statistics Tables of the Reserve Bank of Australia, Önd money supply
M measured by M1 and M3 in Table D3, Column K and Column L. Please convert the
monthly data into quarterly data by keeping the values of money supply for March, June,
September and December in each year.
(c) Calculate the velocity of money P Y =M using M1 and M3, respectively. Plot the
two time series, velocity of money using M1 and velocity of money using M3, in one chart.
Note that output is measured in millions $ and money supply is measured in billions $.
It might be useful to convert them into the same units. Please use time (quarters) as the
x-axis and velocity of money as the y-axis in your time series plot.
(d) From your plot in part (c), how do velocity of M1 and velocity of M3 change over
time? Can you o§er an explanation to rationalize your Öndings? Explain.
(e) What does the quantity theory of money suggest? Do the empirical Öndings you
1
obtain from part (c) and part (d) support the quantity theory of money in Australia?
Explain - (10 marks) The Rate of Return Equality in practice. Consider the following data
series from the Federal Reserve Bank of St. Louis (FRED) between Jan 1, 1981 and Jan 1,
2019.
Capital Stock at Constant National Prices for United States, Millions of 2017 U.S.
Dollars, Annual, Not Seasonally Adjusted (RKNANPUSA666NRUG);
Net value added of corporate business: Net operating surplus, Billions of Dollars, Annual, Not Seasonally Adjusted (W322RC1A027NBEA);
Consumer Price Index: Total All Items for the United States, Index 2015=100, Annual,
Not Seasonally Adjusted (CPALTT01USA661S);
Long-Term Government Bond Yields: 10-year: Main (Including Benchmark) for the
United States, Percent, Annual, Not Seasonally Adjusted (IRLTLT01USA156N);
Consumer Price Index: Total All Items for the United States, Growth Rate Previous
Period, Annual, Not Seasonally Adjusted (CPALTT01USA657N).
(a) Construct the return on capital by using the net operating surplus divided by capital
stock. Notice that the data on capital stock is in millions of 2017 U.S. dollars, but the data
on net operating surplus is in billions of dollars. Please convert the data series properly to
Önd the return on capital and include your calculated return on capital in your appendix.
(b) Construct the real interest rate on long-term government bonds. Notice that the
long-term government bond yields are nominal interest rate. Please convert the yields into
real interest rates and include your calculated return on government bonds in your appendix.
(c) Plot the return on capital that you Önd in part (a) and the return on government
bonds that you Önd in part (b) in one graph, where the horizontal axis shows the years.
Does the rate of return equality hold from your answers in part (a) and part (b)?