2.) This question uses the general monetary model, in which L is no longer assumed constant and money demand is inversely related to the nominal interest rate. Consider the same scenario described in the beginning of the previous question. In addition, the bank deposits in Japan pay 3% interest; i¥ = 3%.
a.) Calculate the interest rate paid on Korean deposits.
b.) Using the definition of the real interest rate (nominal interest rate adjusted for
inflation), show that the real interest rate in Korea is equal to the real interest rate in Japan. (Note that the inflation rates you calculated in the previous question will apply here.)
c.) Suppose the Bank of Korea increases the money growth rate from 12% to 15% and the inflation rate rises proportionately (one for one) with this increase. If the nominal interest rate in Japan remains unchanged, what happens to the interest rate paid on Korean deposits?
d.) Using time series diagrams, illustrate how this increase in the money growth rate affects the money supply, MK; Korea’s interest rate; prices, PK; real money supply; and Ewon/¥ over time. (Plot each variable on the vertical axis and time on the horizontal axis.)
a. o,5
b. both 3%
c.interest on Korean deposits will go down
d.
a) To calculate the interest rate paid on Korean deposits, we can use the information given in the question. It states that the bank deposits in Japan pay 3% interest (i¥ = 3%). We need to determine the interest rate for Korean deposits.
To calculate the interest rate paid on Korean deposits, we can use the concept of interest rate parity. According to interest rate parity, the interest rates on deposits in two countries should be equal when expressed in the same currency.
So, to find the interest rate paid on Korean deposits, we need to equate the interest rate in Japan (i¥ = 3%) with the interest rate in Korea (i₩) and then solve for i₩.
i¥ = i₩ (using interest rate parity)
3% = i₩
Therefore, the interest rate paid on Korean deposits is also 3%.
b) To show that the real interest rate in Korea is equal to the real interest rate in Japan, we need to use the definition of the real interest rate and consider the inflation rates calculated in the previous question.
The real interest rate is calculated by subtracting the inflation rate from the nominal interest rate.
Real interest rate = Nominal interest rate - Inflation rate
In this case, the nominal interest rate in Korea is 3% (as calculated in part a), and we already calculated the inflation rates for both countries in the previous question.
Let's assume the inflation rate in Japan is denoted as π¥ and the inflation rate in Korea is denoted as π₩.
So, the real interest rate in Korea (r₩) is given by:
r₩ = i₩ - π₩
Similarly, the real interest rate in Japan (r¥) is given by:
r¥ = i¥ - π¥
Since the nominal interest rate in Japan, i¥, is equal to the nominal interest rate in Korea, i₩, as we calculated in part a, we can conclude that:
r₩ = i₩ - π₩ = i¥ - π¥ = r¥
Hence, the real interest rate in Korea is equal to the real interest rate in Japan.
c) In this part, we are given that the Bank of Korea increases the money growth rate from 12% to 15%, and the inflation rate rises proportionately (one for one) with this increase. At the same time, the nominal interest rate in Japan remains unchanged.
When the money growth rate increases, it leads to higher inflation rates. As the inflation rate rises, the real interest rate decreases, assuming the nominal interest rate remains constant. In this case, the nominal interest rate in Japan remains unchanged.
Therefore, if the inflation rate in Korea increases due to the increased money growth rate, the real interest rate in Korea will be lower than before.
d) To illustrate the effects of the increased money growth rate on various variables over time, we can use time series diagrams. We need to plot the following variables: money supply (MK), Korea's interest rate, prices (PK), real money supply, and the exchange rate (Ewon/¥), with time on the horizontal axis.
The specific details for the time series diagrams would depend on the given data and the specific time period mentioned in the question. Please provide the specific data or time period for further assistance in creating the diagrams.