In terms of achieving the dual mandate, we have a real goal and a nominal goal.

ID: 1132395 • Letter: I

Question

In terms of achieving the dual mandate, we have a real goal and a nominal goal. One of the real goals is for real GDP to be at potential GDP and/or real GDP growth to equal potential GDP growth. You will need the following two links to answer this question (we need these data to answer the question, the data should be found by yourself):

Nominal GDP: https://fred.stlouisfed.org/series/GDP

GDP price deflator: https://fred.stlouisfed.org/series/GDPDEF

Potential GDP: https://fred.stlouisfed.org/series/GDPPOT

a)(5 points) Using the most recent data (2018:Q2), calculate real GDP GAP (use Nominal GDP and the GDP price deflator to calculate real GDP).

GDP Gap definition: ((real GDP - potential real GDP) / potential real GDP) x 100

b) (5 points) Why is your answer totally wrong in part a)? Hint, look at the base year - is your GDP gap above biased on the up side or biased on the down side - that is, is the GDP gap in part a) larger than the actual GDP gap or smaller than the actual GDP gap. Explain!

c) (5 points) We discussed how disappointing the potential growth rate of the economy (the speed limit of the economy!) is as of now and also how it was higher in the past. What determines the potential growth rate of the economy?

d) (5 points) Using the link for potential GDP, calculate what the potential growth rate of the economy was for the first quarter of 1995 vs. the first quarter of 2000. Make sure you show all work.

Explanation / Answer

1.High interest rate reduces aggregate demand.So,the keynesians would suggest to lower Nominal interest rate but by an amount less than the natural interest rate because the central bank has achieved it's objective by increasing money supply and interest rate and if the interest rate falls back to the natural level,the economy would be back at the initial point of equilibrium.

Answer-B

2.When there is positive Inflation growth in Nominal HDP>growth in real GDP because Nominal GDP is not adjusted for price change which rises with Inflation,but real GDP is price adjusted which falls when rise in price is greater than rise in wage rate.

Answer-A

3.Real interest is Nominal interest rate- Inflation.

Answer-C

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In terms of achieving the dual mandate, we have a real goal and a nominal goal.

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