Teoria y Politica Monetaria, Instructor: Marco Del Negro.

Problem set 9

1) Say that money growth and inflation in the country of Pizzaland are both 10%. One day, surprisingly, a new central banker is nominated at the head of the Bank of Pizzaland, and decides to implement the Friedman rule right away. Let us say that taxes in Pizzaland are not distortionary. Describe what happens under a) flexible and b) fixed wages. Under which conditions the implementation of Friedman's rule is bound to raise welfare?
2) The country of Maradonia has a fixed exchange rate with the US Dollar. For the past few years fiscal policy has been consistent with the fixed exchange rate policy, and is expected to be consistent forever. One day, however, the President of Maradonia catches people by surprise and announces that government spending will double, and that taxes will not increase. Using a graph, describe the time path of prices, exchange rate, international reserves and real money balances before and after the announcement.