Chapter 29 — Exercises

Section A — Quantity theory

A1. MV = PY. If M grows 8%, V is constant, and Y grows 3%, what is the predicted inflation rate? A2. Why doesn't the quantity theory work perfectly in the short run? A3. Apply MV = PY to Zimbabwe's hyperinflation. What happened to M?

Section B — Types of inflation

B1. Classify each as demand-pull or cost-push: (a) government stimulus → consumer spending surge, (b) oil price spike → higher transport costs, (c) supply-chain disruption → higher production costs, (d) booming stock market → wealth effect → more spending. B2. The 2021–23 inflation was both. Explain how demand-pull and cost-push interacted. B3. The 1970s stagflation was primarily cost-push. Why couldn't standard Keynesian policy fix it?

Section C — Expectations

C1. Why are inflation expectations "the most important variable" in determining actual inflation? C2. During the 2021–23 surge, inflation hit 9.1% but long-run expectations stayed near 2%. Why? C3. What happens to the Phillips curve when expectations become unanchored?

Section D — The Phillips curve

D1. Draw the short-run and long-run Phillips curves. Explain why the long-run curve is vertical. D2. If the Fed pushes unemployment from 4% to 3% (below NAIRU of 4.5%), what does the Phillips curve predict? D3. "The Phillips curve is dead." Evaluate. Has the trade-off between inflation and unemployment disappeared?

Section E — Policy

E1. "The Fed should always keep unemployment as low as possible." Use the Phillips curve to explain why this doesn't work. E2. Compare the Volcker approach (sharp tightening, deep recession, rapid disinflation) to a hypothetical gradual approach. Which works better? Why? E3. If a supply shock hits (oil prices spike), should the Fed raise rates? Apply the demand-pull vs. cost-push distinction.

Section F — Data lookup

F1. Look up the velocity of M2 (FRED: M2V). How has it changed since 2000? Since 2020? F2. Plot the Phillips curve for the last 20 years: unemployment on the x-axis, core inflation on the y-axis. Does the short-run trade-off appear?

Section G — Reflection

  • The quantity theory says inflation is "always and everywhere a monetary phenomenon." Do you agree?
  • Expectations anchoring saved the economy in 2022–23. What would happen if the Fed lost its credibility?

Selected answers in appendices/answers-to-selected.md.