Advanced Macroeconomics 5th Edition Romer Solutions Manual Full Chapter PDF

Advanced Macroeconomics 5th Edition
Romer Solutions Manual

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SOLUTIONS TO CHAPTER 6
Problem 6.1
(a) The IS curve in Figure 6.1 is given by
1
(1) ln Yt  a  ln Yt 1  rt , where a ≡ – (1/θ)lnβ.

The slope of the IS curve is given by dr/dY for a given Yt+1. Differentiating equation (1) yields
1 1
(2) dYt   dr t ,
Yt 
and thus the slope is given by
dr t 
(3)  .
dYt IS Yt
Thus an increase in θ increases the slope in absolute value and makes the IS curve steeper. Intuitively, an
increase in the coefficient of relative risk aversion, θ, means that households are less willing to substitute
consumption across time. Thus any given change in r results in a smaller change in consumption and
therefore output along the IS curve. In addition to the change in slope, an increase in θ reduces the
constant term, a, and thus causes the IS curve to shift down.
The LM curve is given by the combinations of Y and r that satisfy the following equation for a given
level of real money holdings:
1/ 
Mt  1  rt

(4)  Yt  /    .
Pt  rt
Taking the natural log of both sides gives us
M   1 1
(5) ln t   ln Yt  ln(1  rt )  ln rt .
 Pt    
The slope of the LM curve is given by dr/dY for a given M/P. From equation (5)
 1 1 1 1 1
(6) 0  dYt  drt  drt .
 Yt  1  rt  rt
Solving for dr/dY gives us
dr t  r (1  rt )
(7)  t .
dYt LM Yt
Thus an increase in θ also makes the LM curve steeper.
(b) The IS curve does not depend on χ at all, so it is unchanged. From equation (7) we can see that a
change in χ does not affect the slope of the LM curve. From equation (4) we can see that a decrease in χ
increases the demand for real money balances at a given level of output and the real interest rate. This
implies that the LM curve must shift up. Intuitively, with a fixed real money supply, any given level of
output would now require a higher real interest rate for the demand for money to equal the fixed supply.
Thus the new LM curve associated with the lower value of χ must lie above the old LM curve.
(c) Again, the IS curve does not depend on Γ(•) at all, so it does not change. As in the text, consider a
balanced budget change in Mt/Pt and Ct. Specifically, suppose the household raises Mt/Pt by dm and
lowers Ct by [it/(1 + it)]dm. At the margin, this change must not affect utility. The utility cost of this
change is still U'(Ct)[it/(1 + it)]dm. With our modification to the utility function, the utility benefit is now
given by B Γ'(Mt/Pt)dm. Thus the first-order condition for optimal money holdings is now
6-2 Solutions to Chapter 6
M  i
(8) B'  t   t U (C t ) .
 Pt  1  i t
Given the form of Γ(•) and U(•) , and the fact that Ct = Yt this implies

M  i
(9) B  t   t Yt   .
 Pt  1 it
Dividing both sides of equation (9) by B and then taking both sides of the resulting expression to the
exponent -1/χ, we have
1/ 
Mt  1  rt

(10)  B1 /  Yt  /    ,
Pt  rt 
where we have also used the fact that with the price level fixed, the real and nominal interest rates are
equivalent. Intuitively, a decrease in B reduces the utility from holding any given quantity of real money
balances. Thus, as we can see from equation (10), it reduces optimal money holdings for any given level
of output and the real interest rate. This implies that the LM curve must shift down. With the lower value
of B, any given level of output must now be associated with a lower real interest rate for real money
demand to remain equal to the fixed real money supply.
Problem 6.2
(a) We need to find the average cost per unit time of conversions plus foregone interest, which we will
denote AC. The cost of conversions in nominal terms is P times C and the number of conversions per
unit time is 1/τ. Average foregone interest per unit time is average money holdings, αYPτ/2 multiplied
by the nominal interest rate, i. Thus,
PC YP
(1) AC   i.
 2
The first-order condition for τ is
 AC PC YP
(2)   i0.
 2 2
This simplifies to
C Yi
(3)  .
2 2
Solving for the optimal choice, τ* yields
12
 2C 
(4) *    .
 Yi 
Note that  2 AC   2  2 PC 3  0 and so τ* is a minimum.
(b) Average real money holdings are given by

M Y
(5)  .
P 2
Substituting the optimal choice of τ* given by equation (4) into equation (5) yields
12
M Y  2C 
(6)    .
P 2  Yi 
This simplifies to
12
M  CY 
(7)   .
P  2i 
Solutions to Chapter 6 6-3
Taking the natural log of both sides of equation (7) gives us

(8) ln(M / P)  1 / 2[ln   ln Y  ln C  ln 2  ln i] .
Differentiating both sides of (8) with respect to i yields
1  [ M / P] 11
(9)  .
M/P i 2i
Thus, the elasticity of real money holdings with respect to i is given by
 [ M / P] i 1
(10)  .
i M/P 2
Differentiating both sides of (8) with respect to Y yields
1  [ M / P] 1 1
(11)  .
M/P  Y 2Y
Thus, the elasticity with respect to Y is given by
 [ M / P] Y 1
(12)  .
 Y M/P 2
Thus, average real money holdings are decreasing in i and increasing in Y.
Problem 6.3
(a) Substituting the consumption function, Ct = a + bYt-1, and the assumption about investment,
It = Kt* – cYt-2, into the equation for output, Yt = Ct + It + Gt, yields
(1) Yt = a + bYt-1 + Kt* – cYt-2 + Gt.
Substituting for the desired capital stock, Kt* = cYt-1 , and for the constant level of government
purchases, Gt = G , yields
(2) Yt = a + bYt-1 + cYt-1 – cYt-2 + G .
Collecting terms in Yt-1 gives us output in period t as a function of Yt-1, Yt-2 and the parameters of the
model:
(3) Yt = a + (b + c)Yt-1 – cYt-2 + G .
(b) With the assumptions of b = 0.9 and c = 0.5, output in period t is given by
(4) Yt = a + 1.4Yt-1 – 0.5Yt-2 + G .
Throughout the following, the change in a variable represents the change from the path that variable
would have taken if G had simply remained constant at G .
In period t,
(5) Yt = a + 1.4Yt-1 – 0.5Yt-2 + G + 1,
and thus the change in output from the path it would have taken is given by
(6) Yt = +1.
In period t + 1, using the fact that equation (4) will hold in all future periods,
(7) Yt+1 = 1.4Yt – 0.5Yt-1 = 1.4(+1) – 0.5(0) = +1.4.
In period t + 2,
(8) Yt+2 = 1.4Yt+1 – 0.5Yt = 1.4(+1.4) – 0.5(+1) = +1.46.
In period t + 3,
(9) Yt+3 = 1.4Yt+2 – 0.5Yt+1 = 1.4(+1.46) – 0.5(+1.4) = +1.344.
With similar calculations, one can show that Yt+4 = +1.15, Yt+5 = 0.938 and so on. Thus output
follows a "hump-shaped" response to the one-time increase in government purchases of one. The
maximum effect is felt two periods after the increase in G and the effect then goes to 0 over time.
Problem 6.4
(a) The short-side rule implies that the level

that generates the maximum output is the W/P LS
intersection of the labor supply and labor
demand curves, where there is no
unemployment. Thus, a price level of P*,
seen at the right, maximizes output. W̅/P′
W P*
(b) A price level (here given by P') that is
above the level that generates maximum
output will cause more labor to be supplied
than is demanded, thus causing LD
unemployment and output that is lower than
the maximum. See the figure at right. L' L* L
Problem 6.5
Suppose the increase in g occurs in time period t and define g  gH – gL > 0. In what follows, the
change in a variable refers to the difference between its actual value and the value it would have had in
the absence of the rise in g.
(a) In this case, unemployment does not need to change in order for price inflation to remain constant.
Wage inflation simply rises by g since it is given by
(1)  wt  t  g t .
Since price inflation is given by
(2)  t   t 1   (u t  u) ,
 then remains constant and u remains equal to u .
(b) Since price inflation is given by

(3) t = tw – gt,
then
(4) t = tw – g,
and so wage inflation must rise by g in order for u
price inflation to remain constant. Since wage
inflation is given by
(5)  w w
t   t 1   (u t  u ) ,
this means that unemployment must fall in period u • • • • •
t. More formally, we need  w
t  g and with
g
 w
t 1  0 and u  0 , equation (5) implies u •

(6) g t   (u t ) ,
or simply
1
(7) u t   g .

t-1 t t+1 t+2 t+3 t+4
t1 to be g higher than it would have been since g is g higher than it

In period t + 1 we again require  w
would have been. Note that  t is g higher, and so from
w
(8)  w w
t 1   t   (u t 1  u ) ,
we can see that  w t 1 will be g higher if u t 1  u . Thus the period after the shock, unemployment must
return to u̅ if priceinflation is to remain constant. The required path of the unemployment rate is shown
in the figure at right. The rise in g causes a one-period drop in u.
t must rise by g for price inflation to be constant. Since wage inflation is given by
(c) As in part (b),  w
(9) wt   t 1   (u t  u ) ,
this means that unemployment must fall in period t. As in part (b), the required change in the
unemployment rate is
1
(10) u t   g .

In period t + 1 we require  w t 1 to be g high since g is g

higher. Equation (9) holds for all u
periods and so in period t + 1, we can write
(11) wt 1   t   (u t 1  u ) .
Since t = 0, for  w t 1  g , we again gL
u •
require unemployment to be lower than it would 
have been and
1 gH
(12) u t 1   g . u • • • • •
 
The same is true in each following period. Thus in this

case, the rise in g requires a permanent drop in the
unemployment rate in order for price inflation to remain t-1 t t+1 t+2 t+3 t+4
constant. Note that in the absence of the shock, the
unemployment rate is u t  u  (1 ) g L . That is because we assume that unemployment is initially at the
level that causes price inflation to be constant. Here, if g is not changing, that requires wage inflation to
be constant. Substituting equation (3) lagged one period into equation (9) gives us
(13)  w w
t   t 1  g t 1   (u t  u ) .
And thus, in order for wage inflation to be constant when g equals gL , as it does in period (t – 1), the
unemployment rate must equal u  (1 ) g L . In period t, when u falls by (1/)g, the level of the
unemployment rate becomes u  (1 ) g L  (1 )g  u  (1 )(g L  g H  g L ) or simply u  (1 )(g H ) . It
then remains at that level thereafter.
(d) As in parts (b) and (c),  w t must rise by g for price inflation to be constant. To see what this
implies for unemployment in period t, we first need to calculate the change in ĝ t due to the change in g.
Since
(14) ĝ t  ĝ t 1  (1  )g t ,
we can write
(15) ĝ t  (1  )g .
Wage inflation in period t is given by

(16) w
t   t 1  ĝ t   (u t  u ) .
Equations (15) and (16), along with the fact that we require  w
t  g imply
(17) g  (1  )g  u t .
Thus the change in unemployment required for price inflation to be constant in period t is
1
(18) u t   [1  (1  )]g .

t1 be g higher. Since equation (14) holds

In period t + 1, constant price inflation again requires that  w
in all periods, the change in ĝ for period t + 1 is
(19) ĝ t 1  ĝ t  (1  )g .
Substituting equation (15) into equation (19) yields
(20) ĝ t 1  (1  )g  (1  )g ,
or simply
(21) ĝ t 1  [(1  )  (1  )]g .
Wage inflation in period t + 1 is given by
(22)  wt 1   t  ĝ t 1   (u t 1  u ) .
Equations (21) and (22), along with the fact that we require  w
t 1  g imply
(23) g  [(1  )  (1  )]g  u t 1 .
Thus the change in the unemployment rate required for constant price inflation in period t + 1 is given by
1
(24) u t 1   [1  (1  )  (1  )]g .

Similar analysis for period t + 1 would yield the following required change in the unemployment rate:
1
(25) u t  2   [1  (1  )  (1  )  2 (1  )]g .

And in general, in period t + s, the change in the unemployment rate required for constant price inflation
is given by
1
(26) u t  s   [1  (1  )  (1  )  2 (1  )    s (1  )]g .

Allowing s to go to infinity, we can write
(27) 1  (1  )  (1  )  2 (1  )    1  [(1  )(1    2  )] .
Since 0 <  < 1, the infinite series 1 + ρ + ρ2 + … converges and we can write
1
(28) 1  (1  )  (1  )  2 (1  )    1  [(1  ) ]  11  0 .
(1  )
Thus
(29) lim u t  s  0 .
s 
In this case, if price inflation is to remain constant when g rises, the unemployment rate must fall at time t
and then rise back until it asymptotically approaches its original value.
Problem 6.6
(a) Substitute the IS equation,
(1) Yt = − rt/θ
into the money-market equilibrium condition,
(2) m  p  L(r  e , Y) ,
to obtain
r
(3) m  p  L(r   e , t ) .

With P  P and e = 0, equation (3) simplifies to
r
(4) m  p  L(r, t ) ,

where p  ln(P) . Differentiating both sides of equation (4) with respect to m gives us
dr  1 dr
(5) 1  L r  LY ( ) .
dm  dm
Solving for dr/dm yields
dr 1
(6)  .
dm 1
Lr  LY ( )

1
Since L r  0 , L Y  0 , and < 0, dr/dm < 0. Thus an increase in the nominal money supply does

lower the real interest rate.
(b) Substituting the assumption that e = 0 into equation (3) gives us

r
(7) m  p  L(r, t ) .

Differentiating both sides of equation (7) with respect to m yields
dp dr  1 dr
(8) 1   Lr  LY ( ) .
dm dm  dm
Solving for dr/dm leaves us with
dr 1  dp dm
(9)  .
dm 1
Lr  LY ( )

As shown in part (a), the denominator of dr/dm is negative. With 0 < dp/dm < 1, the numerator is strictly
between 0 and 1. Thus dr/dm < 0 and so an increase in the nominal money supply again reduces the real
interest rate. Comparing equations (6) and (9), we can see that, since 0 < dp/dm < 1, dr/dm is smaller in
absolute value here. Thus a given change in m causes a smaller change in r when p is not completely
fixed. Or conversely, a larger change in m is required for any given change in r.
(c) Differentiate both sides of equation (3) with respect to m to yield

dp dr de  1 dr
(10) 1   Lr  e  Lr  e  LY ( ) .
dm dm dm  dm
Solving for dr/dm gives us
dr 1  dp dm L r   e de dm
(11)   .
dm 1 1
Lr  e  LY ( ) Lr  e  LY ( )
 
As shown in part (b), the first term on the right-hand side of equation (11) is negative. The denominator
of the second term on the right-hand side is negative, as shown previously. Since L e  0 and
r 
e
d /dm > 0, the numerator is also negative and thus that second term is positive. Thus dr/dm < 0 again,
meaning that an increase in the nominal money supply, m, lowers the real interest rate. Comparing
equations (9) and (11) we can see that dr/dm is larger in absolute value here. Thus, if expected inflation
increases when the nominal money supply rises – as it does here – a given change in m has a larger effect
on the real interest rate. Thus a given change in r requires a smaller change in m than in part (b).
(d) We can substitute the assumptions that dp/dm = 1 and de/dm = 0 into equation (10) to obtain
dr  1 dr
(12) 1  1  L r   e  LY ( ) .
dm  dm
And thus
dr
(13) 0.
dm
With complete and instantaneous price adjustment, a change in the nominal money supply does not affect
the real interest rate.
Problem 6.7
(a) Recall that the AD curve is derived from the IS and MP curves. The IS curve is given by
(1) y(t) = – [i(t) – (t)]/θ,
with y'(•) < 0 so that the IS curve is downward-sloping in (y, r) space. The monetary-policy rule is given
by
(2) r(t) = r(y(t) – y (t),(t)),
which, with the assumption that y (t) = 0, simplifies to
(3) r(t) = r(y(t),(t)),
with the constraint that the nominal interest rate, i(t) = r(t) + (t), cannot be negative. Given this
constraint, we can treat the MP curve as horizontal over the range of output for which the Federal
Reserve's desired value of r would result in a negative value of i; that is, over the range of y for which
r(y(t),(t)) +  < 0 or r(y(t),(t)) < – .
See the figure at right. It is drawn for

r
an inflation rate 1 at which the non-
MP(1) MP( ~
)
negative nominal interest rate constraint
MP(2)
is not binding. The flat portion of the
MP(1) curve is horizontal at a real r2
interest rate equal to – 1 . At the
intersection of the IS curve and the r1
MP(1) curve, the initial real interest
~r
rate is r1 and the initial level of output is
y1.
IS
Now consider a fall in the inflation rate
to ~
  1 . The IS curve is unaffected.
The upward-sloping portion of the MP
curve shifts down since r > 0; the Fed
would like to set a lower real interest y2 y1 ~y y
rate at lower levels of inflation. But the
horizontal portion of the MP curve shifts up; the real interest rate at which the constraint of a non-
negative nominal interest rate becomes binding is now higher (at a 5 percent rate of inflation, the Fed
cannot achieve a real interest rate below negative 5 percent; at a 2 percent rate of inflation, the Fed
cannot achieve an r below negative 2 percent).
The new MP curve is labeled MP( ~ ) in the figure. As drawn, at the level of output where planned and
actual expenditures are equal given the Federal Reserve's choice of r, the constraint is just binding; that
is, r(~y, ~   0 or r(~
)  ~ y, ~
)  ~
 . In terms of the figure, this means that the IS curve intersects the kink
in the MP curve. The fall in inflation raises output from y1 to ~y . Thus over the range of inflation rates
exceeding ~ , a drop in inflation increases output along the AD curve as it does in our standard model.
Now suppose that inflation falls farther to  2  ~ .


Again, the upward-sloping portion of the MP curve AD
shifts down and the horizontal portion shifts up. The
new MP curve is labeled MP(2) in the figure above. At
the intersection of IS and this MP(2) curve, we can see ~
that the real interest rate rises to r2 and output falls to y2. 
Intuitively, the nominal interest rate, i = r + , is already
at zero at an inflation rate of ~ . Thus at lower inflation
rates such as 2, the real interest rate must be higher
since i will still equal zero. That rise in the real interest ~y y
rate reduces the level of output at which planned and
actual expenditures are equal. Thus as inflation falls below ~ , output falls below ~y . The AD curve is
backward-bending as shown in the second figure.
(b) (i) The initial situation is depicted in the figure


at right. The initial level of output is given by y(0)
(0)
and the initial inflation rate is given by (0). The
initial level of output is less than the value that 
would generate stable inflation.
Since y(0)  ~ y and the dynamics of inflation are ~


given by
(4)  (t )  [ y(t )  y] ,
where  > 0, inflation falls over time. As inflation
falls, the economy moves down along the AD curve y(0) ~y y
and so output rises from y(0) toward 0. Since ~ y  0,
the constraint that the nominal interest rate cannot
be negative never becomes binding. As output approaches 0, inflation approaches a value of  .
See the figures below.

 y
(0) ~y
time

~
 y (0)
time
(b) (ii) Since the initial value of inflation, (0), is


greater than ~ and ~ y  0 , it must be true that the AD
initial value of y is less than 0. See the figure at
right. (0)
The initial level of output is less than the value that

would generate stable inflation. Since y(0) < 0, ~

inflation falls over time. As inflation falls, the
economy moves down along the AD curve with
output rising and inflation falling. At some time t1,
the economy reaches ~ and ~y . At that point,
y(0) ~y y
however, output is still less than 0. Thus inflation
continues to fall. In addition, the nominal interest
rate is at zero and cannot go any lower. Thus as inflation falls below ~ , the real interest rate rises,
making output fall. The economy moves down the backward-bending portion of the AD curve with
inflation and output continuing to fall. See the figures below.
 y
(0)
t1 time
~
 ~y
y(0)
t1 time
(b) (iii) The initial value of inflation, (0), is less


than ~ and the initial value of output, y(0), is less AD
than 0 which, in turn, is less than ~y . We are on the
backward-bending portion of the AD curve and the
nominal interest rate is zero. See the figure at right.
~

Since the initial level of output is less than the value
that would generate stable inflation, inflation falls
over time. As inflation falls, the economy moves (0)
down along the backward-bending portion of the
AD curve and therefore output falls as well. ~y
y(0) y
Intuitively, since the nominal interest rate is already
at zero and cannot go any lower, as inflation falls,
 y
~

~y
(0)
time
y(0)
time
the real interest rate rises. Thus output must fall. See the figures above.
Problem 6.8
The MP equation is now given by
(1) rt  by t  u MP
t ,
where
(2) u MP
t  MP u MP MP
t 1  e t .
The IS curve no longer contains a shock term and is given by
1
(3) y t  E t [ y t 1 ]  rt .

Substituting equation (1) into (3) gives us

1
(4) y t  E t [ y t 1 ]  [by t  u MPt ],

which simplifies to
 1
(5) y t  E t [ y t 1 ]  u MP
t .
b b
Note that equation (5) holds in all future periods. Denoting ϕ ≡ θ/(θ + b), this means we can write

(6) y t  j   E t  j[ y t  j1 ]  u MP t j for j = 1,2,3, …

Taking expectations of both sides of (6) as of time t, and using equation (2) and the law of iterated
projections gives us
 j
(7) E t [ y t  j ]   E t [ y t  j1 ]   MP u MP
t .

We can now iterate equation (5) forward. First, substitute for E t[Y t + 1] to obtain
 
(8) y t   u MP t   ( E t [ y t 2 ]   MP u MP t ).
 
Now substitute for E t[Y t + 2] to yield
 2 
(9) y t   u MP t   MP u MP
t   2 ( E t [ y t 3 ]   2MP u MP
t ),
  
and so on. We can therefore rewrite (9) as
  
(10) y t  (1    MP   2  2MP  )   u MP n
t   lim  E t [ y t  n ] .
   n 
Since ϕ < 1, the limit would fail to converge to 0 only if E t[Y t + n] diverged. Since this cannot happen—
agents cannot expect output to diverge—then the limit converges to 0. Thus, equation (10) becomes
 /
(11) y t  u MP
t .
1    MP
Using the definition of φ ≡ θ/(θ + b) we can write (11) as
1

(12) y t  b u MP ,
  b    MP t
b
or simply
1
(13) y t  u MP
t .
  b    MP
Problem 6.9
(a) Substituting the MP equation given by
(1) r t = by t ,
into the IS equation given by
1
(2) y t  E t [ y t 1 ]  rt  u IS t ,

gives us
b
(3) y t  E t [ y t 1 ]  y t  u IS t .

Equation (3) simplifies to
  IS
(4) y t  E t [ y t 1 ]  ut .
b b
If we conjecture that the solution is of the form

(5) y t  Au IS
t ,
which implies that
(6) E t [ y t 1 ]  AE t [u IS
t 1 ] ,
then equation (4) becomes

  IS
(7) Au IS
t  AE t [u IS
t 1 ]  ut .
b b
Because u IS IS IS
t   IS u t 1  e t holds for each period and because e is white noise, then we can write
(8) E t [u IS IS
t 1 ]   IS u t .
Substituting equation (8) into (7) yields
  IS
(9) Au IS
t  AISu IS
t  ut .
b b
Dividing both sides of equation (9) by u IS
t and collecting the terms in A gives us
 
(10) 1  
 IS  A  .
 b  b
  b   IS  
(11)  A ,
 b  b
or

(12) A  .
  b   IS
Thus, our solution is

(13) y t  u IS
t ,
  b   IS
which is the same as the solution given by equation (6.35) in the text.
(b) Substituting our conjectures for inflation and output in period t into the AS equation gives us our
first equation:
(14) Cu IS IS
t  D t 1   t 1  [Au t  B t 1 ] .
Substituting for inflation and output into the new form of the MP equation gives us our second equation:
(15) rt  b(Au IS IS
t  B t 1 )  c (Cu t  D t 1 ) .
Substituting for output in the IS equation yields our third equation:
(16) Au IS IS
t  B t 1  E t [Yt 1 ]  (1/ )rt  u t .
Finally, our conjecture that the solution is of the form
(17) y t  Au IS
t  B t 1 ,
implies that
(18) E t [ y t 1 ]  AE t [u IS
t 1 ]  B t .
Substituting equation (8) for E t [u IS
t 1 ] and our conjecture for πt yields our fourth equation:
(19) E t [ y t 1 ]  A ISu IS IS
t  B(Cu t  D t 1 ) .
Problem 6.10
With this change, equation (6.31) in the text becomes
1
(1) y t  E t [ y t 1 ]  rt  u IS
t .

Substituting the MP curve, given by
(2) rt = byt ,
into equation (1) gives us
1
(3) y t  E t [ y t 1 ]  by t  u IS t .

Collecting the terms in yt yields
  b  IS
(4) 
  y t  E t [ y t 1 ]  u t .
 
Defining ϕ ≡ [θ/(θ + b)] and multiplying both sides of equation (4) by ϕ gives us
(5) y t   E t [ y t 1 ]  u IS
t .
Note that equation (5) holds in all future periods so we can write
(6) y t  j   E t  j[ y t  j1 ]  u IS
t j for j = 1,2,3,…
Since
(7) u IS IS
t  ISu t 1  e t ,
IS
where eIS is white noise, taking expectations of both sides of (6) as of time t implies
j IS
(8) E t [ y t  j ]   E t [ y t  j1 ]   IS ut .
In equation (8), we have used the law of iterated projections, which states that
E t [ E t  j[ y t  j1 ]]  E t [ y t  j1 ] . We can now iterate equation (5) forward. That is, we first express
Et[yt+1] in terms of Et[yt+2] and E t [u IS IS
t 1 ] . We then express Et[yt+2] in terms of Et[yt+3] and E t [u t  2 ] and
so on. Doing this yields
y t  u IS  IS
t    E t [ y t  2 ]   ISu t 
 u IS 2 IS 2 2
 2 IS
t   ISu t     E t [ y t  3 ]   ISu t 
(9)  u IS 2 IS 3 2 2 IS n n
t   ISu t     ISu t    lim   E t [ y t  n ]
n 

 u IS n n
t  lim   E t [ y t  n ] .
1   IS n 
Since both ϕ and ω are less than one, the second term on the right-hand-side of equation (9) will converge
to 0 unless Et[yt+n] diverges. As discussed in the text, for Et[yt+n] to diverge, agents would have to expect
y to diverge, which cannot happen. Thus assuming lim n n E t [ y t  n ]  0 is appropriate.
n 
Substituting for ϕ in equation (9) leaves us with an expression analogous to equation (6.37) in the text:

(10) y t  b u IS
 t ,
1 IS
b
which simplifies to

(11) y t  u IS
t .
  b  IS
From equation (11), we can see that the lower is ω – the less responsive is current demand to
expectations of future output – the smaller is the effect on output of shocks to the IS curve. This is
intuitive because the shocks to the IS curve are serially correlated. If ρIS is positive, then a positive shock
today is expected to raise future output. The less that current demand responds to that increase in
expected future output, the less that output rises today.
Substituting equation (11) for output into the AS equation given by

(12)  t   t 1  y t ,
results in the following expression for inflation that is analogous to equation (6.38) in the text:

(13)  t   t 1  u IS
t .
  b  IS
Problem 6.11
(a) Substituting the expression for aggregate demand, y = m – p, into the equation that defines the
optimal price for firms, p* = p + y, yields p* = p + (m – p) or simply
(1) p* = (1 – )p + m.
Substituting the aggregate price level, p = fp*, and m = m' into equation (1) yields
(2) p* = (1 – )fp* + m'.
Solving for p* gives us

(3) p*  m .
1  (1  )f
Now substitute equation (3) into the expression for the aggregate price level, p = fp*, to obtain
f
(4) p  m .
1  (1  )f
Substituting equation (4) and m = m' into the expression for aggregate demand, y = m – p, yields
f 1  f  f  f 
(5) y  m  m   m ,
1  (1  )f  1  (1  )f 
or simply
(1  f )
(6) y  m .
1  (1  )f
(b) Substituting equation (3), the expression for a firm's optimal price, into the expression describing the
firm's incentive to adjust its price, Kp*2, yields
2
 m 
2
(7) Kp *  K   .
1  (1  )f 
We need to plot this incentive to change price as a function of f, the fraction of firms that change their
price. The following derivatives will be useful:
(8)
 

 Kp *2 2K(1  )(m) 2
,
f 1  (1  )f 3
and
(9)

 2 Kp *2   6K(1  ) (m)
2 2
.
f 2 1  (1  )f 4
When  < 1, [Kp*2 ]/f > 0 and Kp*2

2 [Kp*2 ]/f2 > 0. From equation (7),
at f = 1, Kp*2 = K[m']2 /2 = Km'2. >1
At f = 0, Kp*2 = K2m'2 < Km'2 when
 < 1.
Thus when  < 1, the incentive for a Km'2

firm to adjust its price is an
increasing function of how many
other firms change their price. See
K2m'2
the figure at right.
<1
When  > 1, [Kp*2 ]/f < 0 and

1 f
2 [Kp*2 ]/f2 > 0. From equation (7),
at f = 1, Kp*2 = K[m']2 /2 = Km'2.
At f = 0, Kp*2 = K2m'2 > Km'2 when
 > 1.
Thus when  > 1, the incentive for a firm to adjust its price is a decreasing function of how many other
firms change their price. See the figure.
Kp*2
(c) In the case of  < 1, there can be a
situation where both adjustment by all
firms and adjustment by no firms are Km'2 B
equilibria.
See the figure at right where the menu

cost, Z, is assumed to be such that K2m'2 Z menu
< Z < Km'2. cost
A
Point A is an equilibrium with f = 0.
K2m'2
Consider the situation of a representative
firm at point A. If no one else is changing 1 f
their price, the profits a firm loses by not
changing its price, which are given by
Kp*2 = K2m'2, are less than the menu cost of Z. Thus it is optimal for the representative firm not to
change its price. This is true for all firms and thus no one changing price is an equilibrium.
Point B is also an equilibrium with f = 1. Consider the situation of a representative firm at point B. If
everyone else is changing their price, the profits a firm loses by not changing its price, Kp* 2 = Km'2,
exceed the menu cost of Z. Thus it is optimal for the representative firm to change its price. This is true
for all firms and thus everyone changing price is also an equilibrium.
In the case of  > 1, there can be a Kp*2

situation where neither adjustment by all
firms nor adjustment by no firms are K2m'2 A
equilibria. See the figure at right where
the menu cost, Z, is assumed to be such
that Km'2 < Z < K2m'2.
Z menu
cost
Consider the situation of f = 0 at point A.
If no one else is changing their price, the
profits that a representative firm would Km'2 B
lose by not changing price, Kp*2 = K2m'2,
exceed the menu cost Z. Thus it is optimal
for the firm to change its price. This is fEQ 1 f
true for all firms and thus it cannot be an
equilibrium for no one to change their price.
Now consider the situation of f = 1 at point B. If everyone else is changing their price, the profits that a
representative firm would lose by not changing its price, Kp*2 = Km'2, are less than the menu cost of Z.
Thus it is optimal for the representative firm not to change its price. This is true for all firms and thus it
cannot be an equilibrium for all firms to change their price.
From this discussion, we can see that the equilibrium in this case is for fraction f EQ of firms to change
their price. If fraction fEQ of firms are changing their price, the profit that a representative firm would
lose by not changing its price is exactly equal to the menu cost, Z. Thus the representative firm is
indifferent and there is no tendency for the economy to move away from this point where fraction f EQ of
firms are changing their price.
Problem 6.12
(a) (y1 , r*(y1 )) is the profit a firm receives at aggregate output level y1, if it charges the profit-
maximizing real price, r*(y1 ). (y1 , r*(y0 )) is the profit a firm receives at aggregate output level y1 if it
continues to charge a real price of r*(y0 ), which was the optimal price to charge when aggregate output
was y0 . Thus G = (y1 , r*(y1 )) – (y1 , r*(y0 )) is the additional profit a firm would receive if, when
aggregate output changes from y0 to y1 , the firm changes its price to its new profit-maximizing level.
This represents, therefore, the firm's incentive to change its price in the face of a change in aggregate real
output.
(b) The second-order Taylor approximation will be of the form

 G   2 
(1) G  G y  y   y1  y 0   1   G y  y 2 .
2   y12  1 0
1 o   y1 y  y 
 1 0  y1  y 0 
Clearly, G evaluated at y1 = y0 is equal to zero. In addition
(2) G/y1 = 1(y1, r*(y1)) + 2(y1, r*(y1))[r* '(y1)] – 1(y1, r*(y0)).
Evaluating this derivative at y1 = y0 gives us
(3) G/y1 |y1=y0 = 1(y0, r*(y0)) + 2(y0, r*(y0))[r* '(y0)] – 1(y0, r*(y0)) = 0.
Since r*(y0) is defined implicitly by 2(y0, r*(y0)) = 0, the right-hand side of equation (3) is equal to zero.
Using equation (2) to find the second derivative of G with respect to y1 gives us
(4) 2G/y12 = 11(y1, r*(y1)) + 12(y1, r*(y1))[r* '(y1)] +
[21(y1, r*(y1)) + 22(y1, r*(y1))r* '(y1)][r* '(y1)] + 2(y1, r*(y1))[r* ''(y1)] –

11(y1, r*(y0)).
Using the fact that 2(y1, r*(y1)) = 0 and 12(y1, r*(y1)) = 21(y1, r*(y1)), equation (4) becomes
(5) 2G/y12 = 11(y1, r*(y1)) + 212(y1, r*(y1))[r* '(y1)] + 22(y1, r*(y1))[r* '(y1)]2 – 11(y1, r*(y0)).
Evaluating this derivative at y1 = y0 leaves us with
(6) 2 G/y12 |y1=y0 = 212(y0, r*(y0))[r* '(y0)] + 22(y0, r*(y0))[r* '(y0)]2.
Now differentiate both sides of the equation that implicitly defines r*(y0), 2 (y0, r*(y0)) = 0, with respect
to y0 to obtain
(7) 21(y0, r*(y0)) + 22(y0, r*(y0))[r* '(y0)] = 0,
and thus
(8) 21(y0, r*(y0)) = – 22(y0, r*(y0))[r* ' (y0)].
(9) 2 G/y12 |y1=y0 = –222(y0, r*(y0))[r* '(y0)]2 + 22(y0, r*(y0))[r* '(y0)]2
= – 22(y0, r*(y0))[r* '(y0)]2.
Thus, since G and G/y1 evaluated at y1 = y0 are both equal to zero, substituting equation (9) into
equation (1) gives us the second-order Taylor approximation:
(10) G  – 22(y0, r*(y0))[r* '(y0)]2[y1 – y0 ]2/2.
(c) The [r* '(y0)]2 component reflects the degree of real rigidity. It tells us how much the firm's profit-
maximizing real price responds to changes in aggregate real output. The 22(y0, r*(y0)) component
reflects insensitivity of the profit function. It tells us the curvature of the profit function and thus the cost
in lost profits from the firm allowing its real price to differ from its profit-maximizing value.
Problem 6.13
(a) Substituting the expression for the nominal wage, w = p, into the aggregate price equation,
p = w + (1 – )l – s, yields p = p + (1 – )l – s. Solving for p yields
(1) p = [(1 – )l – s]/(1 – ).
Substituting the aggregate output equation, y = s + l, and equation (1) for the price level into the
aggregate demand equation, y = m – p, yields
(2) s + l = m – [(1 – )l – s]/(1 – ).
Collecting the terms in l leaves us with
(3) l + [(1 – )l/(1 – )] = m + [s/(1 – )] – s.
Obtaining a common denominator and simplifying gives us
(4) [(1 – ) + (1 – )]l/(1 – ) = m + [1 – (1 – )]s/(1 – ),
or
(5) (1 – )l/(1 – ) = m + [s/(1 – )],
and thus finally, employment is given by
(1  )m  s
(6)   .
(1  )

(1  ) [(1  )m  s] s
(7) p   .
(1  )(1  ) (1  )
Simplifying gives us
(1  )(1  )m  (1  )s  (1  )s (1  )(1  )m  (1  )s
(8) p   .
(1  )(1  ) (1  )(1  )
Thus, the aggregate price level is given by
(1  ) m  s
(9) p  .
(1  )
Substituting equation (6) into the aggregate output equation, y = s + l, and simplifying yields
(1  )m  s s  s  (1  )m  s
(10) y  s   .
(1  ) (1  )
And therefore, output is given by
s  (1  )m
(11) y  .
(1  )
Finally, to get an expression for the nominal wage, substitute equation (9) into w = p:
 (1  ) m  s
(12) w  .
(1  )
The next step is to see the way in which the degree of indexation affects the responsiveness of
employment to monetary shocks. First, use equation (6) to find how employment varies with m:
  (1  )m  s
(13)  .
m (1  )
Taking the derivative of both sides of equation (13) with respect to  gives us
  m (1)[1  ]  (1  )() (  1)
(14)    0.
 (1  ) 2
(1  ) 2
Thus an increase in the degree of indexation, , reduces the amount that employment will change due to a
given monetary shock.
The next step is to examine the way in which the degree of indexation affects the responsiveness of
employment to supply shocks. First, use equation (6) to find how employment varies with s:
 
(15)  .
 s (1  )
Taking the derivative of both sides of equation (15) with respect to  gives us
  s (1)[1  ]  ()() 1
(16)    0.
 (1  ) 2 (1  ) 2
Thus an increase in the degree of wage indexation, , increases the amount that employment will change
due to a given supply shock.
(b) From equation (6), the variance of employment is given by

2 2
 (1  )    
(17) V    Vm    Vs ,
 (1  )   (1  ) 
where we have used the fact that m and s are independent random variables with variances V m and Vs.
We need to find the value of  that minimizes this variance of employment. The first-order condition for
this minimization is
 V  (1  )   (  1)     1 
(18)  2    Vm  2     Vs  0 .
  (1  )   (1  ) 2   (1  )   (1  ) 2 
(19) 0 = (1 – )( – 1)Vm + Vs.
Collecting the terms in  gives us
(20) [(1 – )Vm + Vs ] = (1 – )Vm .
Thus the optimal degree of wage indexation is
(1  )Vm
(21)  
(1  )Vm  Vs
Given the result in part (a) – that indexation reduces the impact on employment of monetary shocks but
increases the impact from supply shocks – equation (21) is intuitive. First, if Vs = 0 – so that there are no
supply shocks – the optimal degree of indexation is one. In addition, the larger is the variance of the
supply shocks relative to the variance of the monetary shocks, the lower is the optimal degree of
indexation.
(c) (i) As stated in the problem:

(22) yi = y – (wi – w),
where   /[ + (1 – )]. Since w = p and wi = ip, equation (22) becomes
(23) yi = y – (i p – p) = y – (i – )p.
From the production function, yi = s + l i and y = s + l and thus we can write
(24) yi – y = (li – l).
Solving equation (24) for employment at firm i yields
(25) li = l + (1/)(yi – y).
Substituting equation (23) for yi – y into equation (25) gives us
(26) li = l – (1/)(i – )p.
Substituting equation (6) for aggregate employment and equation (9) for the price level into equation (26)
gives us
(1  )m  s ( i  ) [(1  )m  s]
(27)  i   
1
(1  )m  s  (i  )[(1  )m  s] ,
(1  ) (1  ) (1  )
which implies
(28)  i 
1
m(1  )  (i  )(1  )  s  (i  ) .
(1  )
(c) (ii) From equation (28), the variance of employment at firm i is given by
2 2
 (1  )  ( i  )(1  )     ( i  ) 
(29) Var ( i )    Vm    Vs .
 (1  )   (1  ) 
The first-order condition for the value of the degree of wage indexation at firm i, i , that minimizes the
variance of employment at firm i is
 Var ( i )  (1  )  ( i  )(1  )     ( i  ) 
(30)  2   (1  )Vm  2  Vs  0 .
 i  (1  )   (1  ) 
(31) {(1 – ) – i[(1 – )] + (1 – )}(1 – )Vm = ( + i – )Vs ,
which implies
(32) i2 Vs + i[(1 – )]2 Vm = [(1 – ) + (1 – )](1 – )Vm – ( – )Vs .
Thus i is given by
[(1  )  (1  )](1  )Vm  [(  )]Vs
(33)  i  .
 2 Vs  [ (1  )]2 Vm
(c) (iii) We need to find a value of  such that the first-order condition given by equation (31) holds
when i = . That is, we need to find a value of  such that if economy-wide indexation is given by , the
representative firm, in order to minimize its employment fluctuations, wishes to choose  as well.
Setting i =  in equation (31) gives us
(34) (1 – )(1 – )Vm = Vs ,
which implies
(35)  [Vs + (1 – )Vm ] = (1 – )Vm .
Thus the Nash-equilibrium value of  is
(1  )Vm
(36)  EQ  .
(1  )Vm  Vs
This is exactly the same value of  we found in part (b); see equation (21). The value of  that minimizes
the variance of aggregate fluctuations in employment is also a Nash equilibrium. Given that other firms
are choosing EQ as their degree of wage indexation, it is optimal for any individual firm to choose EQ as
well.
Problem 6.14
(a) We can use the intuitive reasoning employed to explain equation (11.27) in Chapter 11. Consider an
asset that "pays" – c when the individual climbs a palm tree and pays u when an individual trades and
eats another's coconut. Assume that this asset is being priced by risk-neutral investors with required rate
of return equal to r, the individual's discount rate. Since the expected present value of this asset is the
same as the individual's expected value of lifetime utility, the asset must have price VP while the
individual is looking for palm trees and price VC while the individual is looking for other people with
coconuts.
For the asset to be held, it must provide an expected rate of return of r. That is, its dividends per unit
time plus any expected capital gains or losses per unit time, must equal rV P. When the individual is
looking for palm trees, there are no dividends per unit time. There is a probability b per unit time of a
capital "gain" of (VC – VP) – c; if the individual finds a palm tree and climbs it, the difference in the price
of the asset is VC – VP and the asset "pays" – c at that time. Thus we have
(1) rVP = b(VC – VP – c).
(b) The asset must have price VC while the individual is looking for others with coconuts and must
provide an expected rate of return of r. Thus its dividends per unit time plus any expected capital gains
or losses per unit time, must equal rVC. When the individual is looking for others with coconuts, there
are no dividends per unit time. There is a probability aL per unit time of a capital gain of (VP – VC) + u̅;
if the individual finds someone else with a coconut, trades and eats that coconut, the change in the price
of the asset is (VP – VC) and the asset pays u̅ at that time. Thus we have
(2) rVC = aL(VP – VC + u̅).
(c) Solving for VP in equation (2) gives us

(3) VP = (rVC /aL) + VC – u̅.

(4) r[(rVC /aL + VC – u̅] = b[VC – (rVC /aL) – VC + u̅ – c].
Collecting terms in VC gives us
(5) VC [(r2 /aL) + r + (br/aL)] = r u̅ + b u̅ – bc.
Equation (5) can be rewritten as
(6) VC [r(r + aL + b)]/aL = u̅ (r + b) – bc.
Thus finally, the value of being in state C is given by
aLu (r  b)  bc 
(7) VC  .
r (r  aL  b)
Substituting equation (7) into equation (3) yields the following value of being in state P:
u (r  b)  bc aLu (r  b)  bc 
(8) VP   u.
r  aL  b r (r  aL  b)
Subtracting equation (8) from equation (7) gives us
 u (r  b)  bc   ur  ub  bc  ur  uaL  ub
(9) VC  VP    u  ,
 r  aL  b  r  aL  b
or simply
bc  uaL
(10) VC  VP  .
r  aL  b
(d) For a steady state in which L—the total number of people carrying coconuts—is constant, the flows
out of state C must equal the flows into state C. That is, the number of people finding a trading partner
and eating their coconut per unit time must equal the number of people finding and climbing a tree per
unit time.
The number of people leaving state C per unit time is given by the probability of finding a trading
partner, aL, multiplied by the number of people with coconuts and looking for a trading partner, L. The
number of people entering state C per unit time is given by the probability of finding a tree, b, multiplied
by the number of people looking for a tree, (N - L). For a steady state, these two must be equal. That is,
a steady state requires
(11) (aL)L = b(N – L).
Rearranging equation (11), we have the following quadratic equation in L:
(12) aL2 + bL – bN = 0.
Using the quadratic formula gives us
 b  b 2  4abN  b  9b 2 b
(13) L    ,
2a 2a a
where we have used the given condition that aN = 2b. Also note that we can ignore the solution with
L = –2b/a < 0.
(e) For such a steady-state equilibrium, the gain to an individual from climbing a tree, V C – VP, which
represents moving from having the value of being in state P to the value of being in state C, must be
greater than or equal to the cost to the individual of climbing the tree, c. That is, for a steady-state
equilibrium where everyone who finds a palm tree actually climbs it, we require
(14) VC – VP  c.
Substituting the steady-state value of L = b/a from equation (13) into the expression for V C – VP given in
equation (10), we have
bc  ua (b a ) bc  bu
(15) VC  VP   .
r  a ( b a )  b r  2b
Substituting equation (15) into inequality (14) yields

bc  bu
(16) c,
r  2b
which implies that
(17) bc  bu  c(r  2b) ,
or
(18) c(r  2b  b)  bu .
Thus the cost of climbing a tree must be such that
(19) c  b u̅/(r + b).
Note that the maximum possible cost for which it is optimal to always climb a tree when one is found (as
long as everyone else is doing so) is increasing in the utility gained from eating a coconut and decreasing
in the individual's discount rate.
(f) The situation in which no one who finds a tree climbs it is a steady-state equilibrium for any c > 0. If
no one else is climbing a tree when they find one, it is optimal for an individual not to climb a tree when
she finds one. If the individual were to climb a tree and pick a coconut, she would lose c units of utility
with no hope of ever trading with someone else. If she does not climb the tree, she loses no utility. Thus
it is optimal not to climb the tree. The decision process is the same for every individual who comes
across a tree. Thus no one climbing a tree, or L = 0, is a steady-state equilibrium for any c > 0. This
implies that for 0 < c  b u̅/(r + b), there is more than one steady-state equilibrium. We have shown two:
L = 0 and L = b/a.
In the situation of multiple equilibria, the one with L = b/a involves higher welfare than the one with
L = 0. We have shown that in part (e), with c  bu̅ /(r + b), individuals end up gaining utility each time
they climb a tree. That is why they do it. They know that the utility they will eventually receive by
trading their coconut outweighs the cost of climbing the tree to obtain their coconut. Thus the
equilibrium in which people go through a cycle of searching, climbing, searching, trading and eating,
generates positive utility for the individual. In the equilibrium with L = 0, people never achieve any
positive utility since they never trade and obtain the u̅ units of utility from eating another person's
coconut.
Problem 6.15
(a) The individual's problem is to choose labor supply, Li, to maximize expected utility, conditional on
the realization of Pi . Since Li = Yi, the problem is
(1) max E[(Ci  (1 /  )Yi  ) | Pi ]
Yi
Substituting Ci = PiQi /P and Qi = Li gives us
 P Y 1   
(2) max E  i i  Yi  Pi  .
Yi  P   
Since only P is uncertain, this can be rewritten as
(3) max EPi P  Pi Yi  (1 )Yi  .
Yi
The first-order condition is given by
(4) E[(Pi /P)|Pi ] – Yi-1 = 0,
or
(5) Yi-1 = E[(Pi /P)|Pi ].
Thus optimal labor supply is given by
(6) Yi  E(Pi P) Pi 
1 (  1)
.
Taking the log of both sides of equation (6) and defining yi  lnYi yields
(7) yi = [1/( – 1)]lnE[(Pi /P)|Pi ].
(b) The amount of labor the individual supplies if she follows the certainty-equivalence rule is given by
(in logs)
(8) l i = [1/( – 1)]E[ln(Pi /P)|Pi ].
Since ln(Pi/P) is a concave function of (Pi/P), by Jensen's inequality lnE[(Pi/P)|Pi] > E[ln(Pi/P)|Pi]. Thus
the amount of labor the individual supplies if she follows the certainty-equivalence rule is less than the
optimal amount derived in part (a).
(c) We are given that

(9) ln(Pi /P) = E[ln(Pi /P)|Pi ] + ui , ui  N(0,Vu ).
Taking the exponential function of both sides of equation (9) yields
(10) Pi P  e E ln(Pi P)| Pi e u i .
Now take the expected value, conditional on Pi , of both sides of equation (10):
(11) E Pi P Pi  e E ln (Pi P) | Pi E[e ui Pi ] .
 
Taking the natural log of both sides of equation (11) yields
  
(12) ln E Pi P Pi  Eln(Pi P)|Pi   ln E eu i Pi . 
Note that ln E[e ui Pi ] is just a constant that is independent of Pi. Substituting equation (12) into
equation (7), the expression for the optimal amount of (log) labor supply, gives us
(13)  i  [1   1]  [E[ln(Pi P) | Pi ]  ln E[e u i Pi ]] ,
or simply
(14)  i  [1   1] E[ln(Pi P) | Pi ]  [1   1][ln E[e u i Pi ]] .
The first term on the right-hand side of equation (14), [1/( – 1)]E[ln(Pi/P)|Pi ], is the certainty-
equivalence choice of (log) labor supply and the second term is a constant. Thus the li that maximizes
expected utility differs from the certainty-equivalence rule only by a constant.
Problem 6.16
(a) Model (i) is given by
(1) yt = a' z t - 1 + bet + vt .
This model says that only the unexpected component of money, et, affects output. Model (ii) is given by
(2) yt = ' z t - 1 + mt + vt .
This model says that all money matters for output.
Substituting the assumption about monetary policy, mt = c' z t - 1 + et, into equation (2) yields
(3) yt = ' z t - 1 + [c' z t - 1 + et ] + vt ,
and collecting terms in z t - 1 gives us
(4) yt = (' + c') z t - 1 + et + vt .
The models given by equations (1) and (4) cannot be distinguished from one another. Given some a' and
b, ' = a' – c' and  = b have the same predictions. Intuitively, it is not possible to separate the direct
effect of the z's on output from any possible indirect effect they may have through monetary policy. So it
could be the case that only unexpected money matters and the effect of the z's on output that we observe
is simply their direct effect. However, it could also be the case that the expected component of money
affects output and thus the effect of the z's that we observe consists of both the direct and indirect effects.
(b) Substituting the new assumption about monetary policy, mt = c' zt-1 + ' wt-1 + et , into model (ii)
yields
(5) yt = ' z t - 1 + [c' z t - 1 + ' wt-1 + et ] + vt ,
or collecting the zt-1 terms gives us
(6) yt = (' + c') z t - 1 + ' wt-1 + et + vt .
In this case, it is possible to distinguish between the two theories. Model (i), only unexpected money
matters, predicts that the coefficients on the w's should be zero. Model (ii), all money matters, does not
predict this. Intuitively, since the w's do not directly affect output, if they are correlated with output it
must be due to their indirect effect through their impact on the money supply.
Problem 6.17
(a) Substitute the aggregate price level, p = qpr + (1 - q)pf , into the expression for the price set by
flexible-price firms, pf = (1 – )p + m, to yield
(1) pf = (1 – )[qpr + (1 – q)pf ] + m.
Solving for pf yields
(2) pf [1 – (1 – )(1 – q)] = (1 – )qpr + m.
Since 1 – (1 – )(1 – q) = q +  – q =  + (1 – )q, equation (2) can be rewritten as
(3) pf [ + (1 – )q] = (1 – )qpr + m,
and thus finally
(1  )q  
(4) p f  pr  m  pr  (m  p r ) .
  (1  )q   (1  )q   (1  )q
(b) Since rigid-price firms set pr = (1 – )Ep + Em, we need to solve for Ep, the expectation of the
aggregate price level. Taking the expected value of both sides of p = qpr + (1 – q)pf gives us
(5) Ep = qpr + (1 – q)Epf.
Thus we have
(6) pr = (1 – )[qpr + (1 – q)Epf ] + Em.
The rigid-price firms know how the flexible-price firms will set their price. That is, they know that
flexible-price firms will use equation (4) to set their prices. Thus the rational expectation of the price set
by the flexible-price firms is

(7) Epf  p r  (Em  p r ) .
  (1  )q
   
(8) p r  (1  )qp r  (1  q)p r  (Em  p r )   Em ,
    (1  )q 
which implies
(1  )(1  q)
(9) p r  (1  )p r  Em  (Em  p r ) .
  (1  )q
Defining C  [(1 – )(1 – q)]/[ + (1 – )q], we can rewrite equation (9) as
(10) pr = [1 – (1 – ) + C] = ( + C)Em,
or
(11) pr ( + C) = ( + C)Em,
and thus finally
(12) pr = Em.
Rigid-price firms simply set their prices equal to the expected value of the nominal money stock.
(c) The aggregate price level is given by

(13) p = qpr + (1 – q)pf.
Substituting equation (4) for pf into equation (13) yields
   (1  q)
(14) p  qp r  (1  q)p r  (m  p r )  p r  (m  p r ) .
   (1  ) q    (1  ) q
Finally, from equation (12), we know that pr = Em. Thus the aggregate price level is
(1  q)
(15) p  Em  m  Em .
  (1  )q
We know that y = m – p. Adding and subtracting Em on the right-hand side of this expression yields
(16) y = Em + (m - Em) – p.
(1  q)   (1  )q  (1  q)
(17) y  (m  Em)  (m  Em)  (m  Em) ,
  (1  )q   (1  )q
which simplifies to
(18) y 
q
m  Em .
  (1  )q
(c) (i) From equations (15) and (18), we can see that anticipated changes in m affect only prices.
Specifically, consider the effects of an upward shift in the entire distribution of m, with the realization of
m – Em held fixed. From equation (18) we can see that this will have no effects on real output. In this
case, rigid-price firms get to set their price knowing that m has changed and thus incorporate it into their
price-setting decision.
(c) (ii) Unanticipated changes in m affect real output. That is, a higher value of m given its
distribution—that is, given Em—does raise y as we can see from equation (18). In this case, the rigid-
price firms do not get to observe the higher realization of m and cannot incorporate it into their price-
setting decision and hence the economy does not achieve the flexible-price equilibrium.
In addition, flexible-price firms are reluctant to allow their real prices to change. One can show that
y (1  q)q
(19)  m  Em .
    (1  )q2
The derivative in equation (19) is negative for m > Em.
Thus a lower value of  —a higher degree of "real rigidity"—leads to a higher level of output for any
given positive realization of m – Em. This means that the impact on real output of an unanticipated
increase in aggregate demand is larger the larger is the degree of real rigidity or the more reluctant are
flexible-price firms to allow their real prices to vary.
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“Naw sir,” said the redhaired man slowly. “His neck’s broke clear
off.”
Captain McAvoy sucked a good half of his mustache into his
mouth. “God damn it to hell,” he groaned. “A pretty thing to happen
on a man’s wedding day.”
Second Section
I. Great Lady on a White Horse
M
orning clatters with the first L train
down Allen Street. Daylight rattles
through the windows, shaking the old
brick houses, splatters the girders of the L
structure with bright confetti.
The cats are leaving the garbage cans,
the chinches are going back into the walls,
leaving sweaty limbs, leaving the
grimetender necks of little children asleep.
Men and women stir under blankets and
bedquilts on mattresses in the corners of
rooms, clots of kids begin to untangle to
scream and kick.
At the corner of Riverton the old man with
the hempen beard who sleeps where
nobody knows is putting out his picklestand.
Tubs of gherkins, pimentos, melonrind,
piccalilli give out twining vines and cold
tendrils of dank pepperyfragrance that grow
like a marshgarden out of the musky
bedsmells and the rancid clangor of the
cobbled awakening street.
The old man with the hempen beard who
sleeps where nobody knows sits in the midst
of it like Jonah under his gourd.
immy Herf walked up four creaky flights and knocked at a white

J door fingermarked above the knob where the name Sunderland
appeared in old English characters on a card neatly held in place
by brass thumbtacks. He waited a long while beside a milkbottle, two
creambottles, and a copy of the Sunday Times. There was a rustle
behind the door and the creak of a step, then no more sound. He
pushed a white button in the doorjamb.
“An he said, Margie I’ve got a crush on you so bad, an she said,
Come in outa the rain, you’re all wet....” Voices coming down the
stairs, a man’s feet in button shoes, a girl’s feet in sandals, pink silk
legs; the girl in a fluffy dress and a Spring Maid hat; the young man
had white edging on his vest and a green, blue, and purple striped
necktie.
“But you’re not that kind of a girl.”
“How do you know what kind of a girl I am?”
The voices trailed out down the stairs.
Jimmy Herf gave the bell another jab.
“Who is it?” came a lisping female voice through a crack in the
door.
“I want to see Miss Prynne please.”
Glimpse of a blue kimono held up to the chin of a fluffy face. “Oh I
don’t know if she’s up yet.”
“She said she would be.”
“Look will you please wait a second to let me make my getaway,”
she tittered behind the door. “And then come in. Excuse us but Mrs.
Sunderland thought you were the rent collector. They sometimes
come on Sunday just to fool you.” A smile coyly bridged the crack in
the door.
“Shall I bring in the milk?”
“Oh do and sit down in the hall and I’ll call Ruth.” The hall was
very dark; smelled of sleep and toothpaste and massagecream;
across one corner a cot still bore the imprint of a body on its rumpled
sheets. Straw hats, silk eveningwraps, and a couple of men’s dress
overcoats hung in a jostling tangle from the staghorns of the hatrack.
Jimmy picked a corsetcover off a rockingchair and sat down.
Women’s voices, a subdued rustling of people dressing, Sunday
newspaper noises seeped out through the partitions of the different
rooms.
The bathroom door opened; a stream of sunlight reflected out of a
pierglass cut the murky hall in half, out of it came a head of hair like
copper wire, bluedark eyes in a brittle-white eggshaped face. Then
the hair was brown down the hall above a slim back in a tangerine-
colored slip, nonchalant pink heels standing up out of the
bathslippers at every step.
“Ou-ou, Jimmee...” Ruth was yodling at him from behind her door.
“But you mustn’t look at me or at my room.” A head in curlpapers
stuck out like a turtle’s.
“Hullo Ruth.”
“You can come in if you promise not to look.... I’m a sight and my
room’s a pigeon.... I’ve just got to do my hair. Then I’ll be ready.” The
little gray room was stuffed with clothes and photographs of stage
people. Jimmy stood with his back to the door, some sort of silky
stuff that dangled from the hook tickling his ears.
“Well how’s the cub reporter?”
“I’m on Hell’s Kitchen.... It’s swell. Got a job yet Ruth?”
“Um-um.... A couple of things may materialize during the week.
But they wont. Oh Jimmy I’m getting desperate.” She shook her hair
loose of the crimpers and combed out the new mousybrown waves.
She had a pale startled face with a big mouth and blue underlids.
“This morning I knew I ought to be up and ready, but I just couldn’t.
It’s so discouraging to get up when you haven’t got a job....
Sometimes I think I’ll go to bed and just stay there till the end of the
world.”
“Poor old Ruth.”
She threw a powderpuff at him that covered his necktie and the
lapels of his blue serge suit with powder. “Dont you poor old me you
little rat.”
“That’s a nice thing to do after all the trouble I took to make myself
look respectable.... Darn your hide Ruth. And the smell of the
carbona not off me yet.”
Ruth threw back her head with a shrieking laugh. “Oh you’re so
comical Jimmy. Try the whisk-broom.”
Blushing he blew down his chin at his tie. “Who’s the funnylooking
girl opened the halldoor?”
“Shush you can hear everything through the partition.... That’s
Cassie,” she whispered giggling. “Cassah-ndrah Wilkins ... used to
be with the Morgan Dancers. But we oughtnt to laugh at her, she’s
very nice. I’m very fond of her.” She let out a whoop of laughter. “You
nut Jimmy.” She got to her feet and punched him in the muscle of the
arm. “You always make me act like I was crazy.”
“God did that.... No but look, I’m awfully hungry. I walked up.”
“What time is it?”
“It’s after one.”
“Oh Jimmy I dont know what to do about time.... Like this hat?...
Oh I forgot to tell you. I went to see Al Harrison yesterday. It was
simply dreadful.... If I hadnt got to the phone in time and threatened
to call the police....”
“Look at that funny woman opposite. She’s got a face exactly like
a llama.”
“It’s on account of her I have to keep my shades drawn all the
time ...”
“Why?”
“Oh you’re much too young to know. You’d be shocked Jimmy.”
Ruth was leaning close to the mirror running a stick of rouge
between her lips.
“So many things shock me, I dont see that it matters much.... But
come along let’s get out of here. The sun’s shining outside and
people are coming out of church and going home to overeat and
read at their Sunday papers among the rubberplants ...”
“Oh Jimmy you’re a shriek ... Just one minute. Look out you’re
hooked onto my best shimmy.”
A girl with short black hair in a yellow jumper was folding the
sheets off the cot in the hall. For a second under the ambercolored
powder and the rouge Jimmy did not recognize the face he had seen
through the crack in the door.
“Hello Cassie, this is ... Beg pardon, Miss Wilkins this is Mr. Herf.
You tell him about the lady across the airshaft, you know Sappo the
Monk.”
Cassandra Wilkins lisped and pouted. “Isn’t she dweadful Mr.
Herf.... She says the dweadfullest things.”
“She merely does it to annoy.”
“Oh Mr. Herf I’m so pleased to meet you at last, Ruth does
nothing but talk about you.... Oh I’m afwaid I was indiscweet to say
that.... I’m dweadfully indiscweet.”
The door across the hall opened and Jimmy found himself looking
in the white face of a crookednosed man whose red hair rode in two
unequal mounds on either side of a straight part. He wore a green
satin bathrobe and red morocco slippers.
“What heow Cassahndrah?” he said in a careful Oxford drawl.
“What prophecies today?”
“Nothing except a wire from Mrs. Fitzsimmons Green. She wants
me to go to see her at Scarsdale tomorrow to talk about the
Gweenery Theater.... Excuse me this is Mr. Herf, Mr. Oglethorpe.”
The redhaired man raised one eyebrow and lowered the other and
put a limp hand in Jimmy’s.
“Herf, Herf.... Let me see, it’s not a Georgiah Herf? In Atlahnta
there’s an old family of Herfs....”
“No I dont think so.”
“Too bad. Once upon a time Josiah Herf and I were boon
companions. Today he is the president of the First National Bank and
leading citizen of Scranton Pennsylvahnia and I ... a mere
mountebank, a thing of rags and patches.” When he shrugged his
shoulders the bathrobe fell away exposing a flat smooth hairless
chest.
“You see Mr. Oglethorpe and I are going to do the Song of Songs.
He weads it and I interpwet it in dancing. You must come up and see
us wehearse sometime.”
“Thy navel is like a round goblet which wanteth not liquor, thy
belly is like a heap of wheat set about with lilies ...”
“Oh dont begin now.” She tittered and pressed her legs together.
“Jojo close that door,” came a quiet deep girl’s voice from inside
the room.
“Oh poo-er deah Elaine, she wants to sleep.... So glahd to have
met you, Mr. Herf.”
“Jojo!”
“Yes my deah....”
Through the leaden drowse that cramped him the girl’s voice set
Jimmy tingling. He stood beside Cassie constrainedly without
speaking in the dingydark hall. A smell of coffee and singeing toast
seeped in from somewhere. Ruth came up behind them.
“All right Jimmy I’m ready.... I wonder if I’ve forgotten anything.”
“I dont care whether you have or not, I’m starving.” Jimmy took
hold of her shoulders and pushed her gently towards the door. “It’s
two o’clock.”
“Well goodby Cassie dear, I’ll call you up at about six.”
“All wight Wuthy ... So pleased to have met you Mr. Herf.” The
door closed on Cassie’s tittering lisp.
“Wow, Ruth that place gives me the infernal jimjams.”
“Now Jimmy dont get peevish because you need food.”
“But tell me Ruth, what the hell is Mr. Oglethorpe? He beats
anything I ever saw.”
“Oh did the Ogle come out of his lair?” Ruth let out a whoop of
laughter. They came out into grimy sunlight. “Did he tell you he was
of the main brawnch, dontcher know, of the Oglethorpes of
Georgiah?”
“Is that lovely girl with copper hair his wife?”
“Elaine Oglethorpe has reddish hair. She’s not so darn lovely
either.... She’s just a kid and she’s upstage as the deuce already. All
because she made a kind of a hit in Peach Blossoms. You know one
of these tiny exquisite bits everybody makes such a fuss over. She
can act all right.”
“It’s a shame she’s got that for a husband.”
“Ogle’s done everything in the world for her. If it hadnt been for
him she’d still be in the chorus ...”
“Beauty and the beast.”
“You’d better look out if he sets his lamps on you Jimmy.”
“Why?”
“Strange fish, Jimmy, strange fish.”
An Elevated train shattered the barred sunlight overhead. He
could see Ruth’s mouth forming words.
“Look,” he shouted above the diminishing clatter. “Let’s go have
brunch at the Campus and then go for a walk on the Palisades.”
“You nut Jimmy what’s brunch?”
“You’ll eat breakfast and I’ll eat lunch.”
“It’ll be a scream.” Whooping with laughter she put her arm in his.
Her silvernet bag knocked against his elbow as they walked.
“And what about Cassie, the mysterious Cassandra?”
“You mustn’t laugh at her, she’s a peach.... If only she wouldn’t
keep that horrid little white poodle. She keeps it in her room and it
never gets any exercise and it smells something terrible. She has
that little room next to mine.... Then she’s got a steady ...” Ruth
giggled. “He’s worse than the poodle. They’re engaged and he
borrows all her money away from her. For Heaven’s sake dont tell
anybody.”
“I dont know anybody to tell.”
“Then there’s Mrs. Sunderland ...”
“Oh yes I got a glimpse of her going into the bathroom—an old
lady in a wadded dressing gown with a pink boudoir cap on.”
“Jimmy you shock me.... She keeps losing her false teeth,” began
Ruth; an L train drowned out the rest. The restaurant door closing
behind them choked off the roar of wheels on rails.
An orchestra was playing When It’s Appleblossom Time in
Normandee. The place was full of smokewrithing slants of sunlight,
paper festoons, signs announcing Lobsters Arrive Daily, Eat
Clams Now, Try Our Delicious French Style Steamed
Mussles (Recommended by the Department of Agriculture). They
sat down under a redlettered placard Beefsteak Parties Upstairs
and Ruth made a pass at him with a breadstick. “Jimmy do you think
it’d be immoral to eat scallops for breakfast? But first I’ve got to have
coffee coffee coffee ...”
“I’m going to eat a small steak and onions.”
“Not if you’re intending to spend the afternoon with me Mr. Herf.”
“Oh all right. Ruth I lay my onions at your feet.”
“That doesn’t mean I’m going to let you kiss me.”
“What ... on the Palisades?” Ruth’s giggle broke into a whoop of
laughter. Jimmy blushed crimson. “I never axed you maam, he say-
ed.”
Sunlight dripped in her face through the little holes in the brim of
her straw hat. She was walking with brisk steps too short on account
of her narrow skirt; through the thin china silk the sunlight tingled like
a hand stroking her back. In the heavy heat streets, stores, people in
Sunday clothes, strawhats, sunshades, surfacecars, taxis, broke and
crinkled brightly about her grazing her with sharp cutting glints as if
she were walking through piles of metalshavings. She was groping
continually through a tangle of gritty saw-edged brittle noise.
At Lincoln Square a girl rode slowly through the traffic on a white
horse; chestnut hair hung down in even faky waves over the horse’s
chalky rump and over the giltedged saddlecloth where in green
letters pointed with crimson, read Danderine. She had on a green
Dolly Varden hat with a crimson plume; one hand in a white gauntlet
nonchalantly jiggled at the reins, in the other wabbled a goldknobbed
riding crop.
Ellen watched her pass; then she followed a smudge of green
through a cross-street to the Park. A smell of trampled sunsinged
grass came from boys playing baseball. All the shady benches were
full of people. When she crossed the curving automobile road her
sharp French heels sank into the asphalt. Two sailors were sprawling
on a bench in the sun; one of them popped his lips as she passed,
she could feel their seagreedy eyes cling stickily to her neck, her
thighs, her ankles. She tried to keep her hips from swaying so much
as she walked. The leaves were shriveled on the saplings along the
path. South and east sunnyfaced buildings hemmed in the Park, to
the west they were violet with shadow. Everything was itching
sweaty dusty constrained by policemen and Sunday clothes. Why
hadn’t she taken the L? She was looking in the black eyes of a
young man in a straw hat who was drawing up a red Stutz roadster
to the curb. His eyes twinkled in hers, he jerked back his head
smiling an upsidedown smile, pursing his lips so that they seemed to
brush her cheek. He pulled the lever of the brake and opened the
door with the other hand. She snapped her eyes away and walked
on with her chin up. Two pigeons with metalgreen necks and feet of
coral waddled out of her way. An old man was coaxing a squirrel to
fish for peanuts in a paper bag.
All in green on a white stallion rode the Lady of the Lost
Battalion.... Green, green, danderine ... Godiva in the haughty
mantle of her hair....
General Sherman in gold interrupted her. She stopped a second
to look at the Plaza that gleamed white as motherofpearl.... Yes this
is Elaine Oglethorpe’s apartment.... She climbed up onto a
Washington Square bus. Sunday afternoon Fifth Avenue filed by
rosily dustily jerkily. On the shady side there was an occasional man
in a top hat and frock coat. Sunshades, summer dresses, straw hats
were bright in the sun that glinted in squares on the upper windows
of houses, lay in bright slivers on the hard paint of limousines and
taxicabs. It smelled of gasoline and asphalt, of spearmint and
talcumpowder and perfume from the couples that jiggled closer and
closer together on the seats of the bus. In an occasional
storewindow, paintings, maroon draperies, varnished antique chairs
behind plate glass. The St. Regis. Sherry’s. The man beside her
wore spats and lemon gloves, a floorwalker probably. As they
passed St. Patrick’s she caught a whiff of incense through the tall
doors open into gloom. Delmonico’s. In front of her the young man’s
arm was stealing round the narrow gray flannel back of the girl
beside him.
“Jez ole Joe had rotten luck, he had to marry her. He’s only
nineteen.”
“I suppose you would think it was hard luck.”
“Myrtle I didn’t mean us.”
“I bet you did. An anyways have you ever seen the girl?”
“I bet it aint his.”
“What?”
“The kid.”
“Billy how dreadfully you do talk.”
Fortysecond Street. Union League Club. “It was a most amusing
gathering ... most amusing.... Everybody was there. For once the
speeches were delightful, made me think of old times,” croaked a
cultivated voice behind her ear. The Waldorf. “Aint them flags swell
Billy.... That funny one is cause the Siamese ambassador is staying
there. I read about it in the paper this morning.”
When thou and I my love shall come to part, Then shall I press an
ineffable last kiss Upon your lips and go ... heart, start, who art ...
Bliss, this, miss ... When thou ... When you and I my love ...
Eighth Street. She got down from the bus and went into the
basement of the Brevoort. George sat waiting with his back to the
door snapping and unsnapping the lock of his briefcase. “Well Elaine
it’s about time you turned up.... There aren’t many people I’d sit
waiting three quarters of an hour for.”
“George you mustn’t scold me; I’ve been having the time of my
life. I haven’t had such a good time in years. I’ve had the whole day
all to myself and I walked all the way down from 105th Street to
Fiftyninth through the Park. It was full of the most comical people.”
“You must be tired.” His lean face where the bright eyes were
caught in a web of fine wrinkles kept pressing forward into hers like
the prow of a steamship.
“I suppose you’ve been at the office all day George.”
“Yes I’ve been digging out some cases. I cant rely on anyone else
to do even routine work thoroughly, so I have to do it myself.”
“Do you know I had it all decided you’d say that.”
“What?”
“About waiting three quarters of an hour.”
“Oh you know altogether too much Elaine.... Have some pastries
with your tea?”
“Oh but I dont know anything about anything, that’s the trouble.... I
think I’ll take lemon please.”
Glasses clinked about them; through blue cigarettesmoke faces
hats beards wagged, repeated greenish in the mirrors.
“But my de-e-ar it’s always the same old complex. It may be true
of men but it says nothing in regard to women,” droned a woman’s
voice from the next table.... “Your feminism rises into an insuperable
barrier,” trailed a man’s husky meticulous tones. “What if I am an
egoist? God knows I’ve suffered for it.” “Fire that purifies, Charley....”
George was speaking, trying to catch her eye. “How’s the famous
Jojo?”
“Oh let’s not talk about him.”
“The less said about him the better eh?”
“Now George I wont have you sneer at Jojo, for better or worse
he is my husband, till divorce do us part.... No I wont have you laugh.
You’re too crude and simple to understand him anyway. Jojo’s a very
complicated rather tragic person.”
“For God’s sake don’t let’s talk about husbands and wives. The
important thing, little Elaine, is that you and I are sitting here together
without anyone to bother us.... Look when are we going to see each
other again, really see each other, really....”
“We’re not going to be too real about this, are we George?” She
laughed softly into her cup.
“Oh but I have so many things to say to you. I want to ask you so
many things.”
She looked at him laughing, balancing a small cherry tartlet that
had one bite out of it between a pink squaretipped finger and thumb.
“Is that the way you act when you’ve got some miserable sinner on
the witnessbox? I thought it was more like: Where were you on the
night of February thirtyfirst?”
“But I’m dead serious, that’s what you cant understand, or wont.”
A young man stood at the table, swaying a little, looking down at
them. “Hello Stan, where the dickens did you come from?” Baldwin
looked up at him without smiling. “Look Mr. Baldwin I know it’s awful
rude, but may I sit down at your table a second. There’s somebody
looking for me who I just cant meet. O God that mirror! Still they’d
never look for me if they saw you.”
“Miss Oglethorpe this is Stanwood Emery, the son of the senior
partner in our firm.”
“Oh it’s so wonderful to meet you Miss Oglethorpe. I saw you last
night, but you didn’t see me.”
“Did you go to the show?”
“I almost jumped over the foots I thought you were so wonderful.”
He had a ruddy brown skin, anxious eyes rather near the bridge
of a sharp fragillycut nose, a big mouth never still, wavy brown hair
that stood straight up. Ellen looked from one to the other inwardly
giggling. They were all three stiffening in their chairs.
“I saw the danderine lady this afternoon,” she said. “She
impressed me enormously. Just my idea of a great lady on a white
horse.”
“With rings on her finger and bells on her toes, And she shall
make mischief wherever she goes.” Stan rattled it off quickly under
his breath.
“Music, isnt it?” put in Ellen laughing. “I always say mischief.”
“Well how’s college?” asked Baldwin in a dry uncordial voice.
“I guess it’s still there,” said Stan blushing. “I wish they’d burn it
down before I got back.” He got to his feet. “You must excuse me Mr.
Baldwin.... My intrusion was infernally rude.” As he turned leaning
towards Ellen she smelled his grainy whiskey breath. “Please forgive
it, Miss Oglethorpe.”
She found herself holding out her hand; a dry skinny hand
squeezed it hard. He strode out with swinging steps bumping into a
waiter as he went.
“I cant make out that infernal young puppy,” burst out Baldwin.
“Poor old Emery’s heartbroken about it. He’s darn clever and has a
lot of personality and all that sort of thing, but all he does is drink and
raise Cain.... I guess all he needs is to go to work and get a sense of
values. Too much money’s what’s the matter with most of those
collegeboys.... Oh but Elaine thank God we’re alone again. I have
worked continuously all my life ever since I was fourteen. The time
has come when I want to lay aside all that for a while. I want to live
and travel and think and be happy. I cant stand the pace of
downtown the way I used to. I want to learn to play, to ease off the
tension.... That’s where you come in.”
“But I don’t want to be the nigger on anybody’s safety-valve.” She
laughed and let the lashes fall over her eyes.
“Let’s go out to the country somewhere this evening. I’ve been
stifling in the office all day. I hate Sunday anyway.”
“But my rehearsal.”
“You could be sick. I’ll phone for a car.”
“Golly there’s Jojo.... Hello Jojo”; she waved her gloves above her
head.
John Oglethorpe, his face powdered, his mouth arranged in a
careful smile above his standup collar, advanced between the
crowded tables, holding out his hand tightly squeezed into buff
gloves with black stripes. “Heow deo you deo, my deah, this is
indeed a surprise and a pleajah.”
“You know each other, don’t you? This is Mr. Baldwin.”
“Forgive me if I intrude ... er ... upon a tête à tête.”
“Nothing of the sort, sit down and we’ll all have a highball.... I was
just dying to see you really Jojo.... By the way if you havent anything
else to do this evening you might slip in down front for a few minutes.
I want to know what you think about my reading of the part....”
“Certainly my deah, nothing could give me more pleajah.”
His whole body tense George Baldwin leaned back with his hand
clasped behind the back of his chair. “Waiter ...” He broke his words
off sharp like metal breaking. “Three Scotch highballs at once
please.”
Oglethorpe rested his chin on the silver ball of his cane.
“Confidence, Mr. Baldwin,” he began, “confidence between husband
and wife is a very beautiful thing. Space and time have no effect on
it. Were one of us to go to China for a thousand years it would not
change our affection one tittle.”
“You see George, what’s the matter with Jojo is that he read too
much Shakespeare in his youth.... But I’ve got to go or Merton will be
bawling me out again.... Talk about industrial slavery. Jojo tell him
about Equity.”
Baldwin got to his feet. There was a slight flush on his
cheekbones. “Wont you let me take you up to the theater,” he said
through clenched teeth.
“I never let anyone take me anywhere ... And Jojo you must stay
sober to see me act.”
Fifth Avenue was pink and white under pink and white clouds in a
fluttering wind that was fresh after the cloying talk and choke of
tobaccosmoke and cocktails. She waved the taxistarter off merrily
and smiled at him. Then she found a pair of anxious eyes looking
into hers seriously out of a higharched brown face.
“I waited round to see you come out. Cant I take you somewhere?
I’ve got my Ford round the corner.... Please.”
“But I’m just going up to the theater. I’ve got a rehearsal.”
“All right do let me take you there.”
She began putting a glove on thoughtfully. “All right, but it’s an
awful imposition on you.”
“That’s fine. It’s right round here.... It was awfully rude of me to
butt in that way, wasn’t it? But that’s another story.... Anyway I’ve met
you. The Ford’s name is Dingo, but that’s another story too....”
“Still it’s nice to meet somebody humanly young. There’s nobody
humanly young round New York.”
His face was scarlet when he leaned to crank the car. “Oh I’m too
damn young.”
The motor sputtered, started with a roar. He jumped round and
cut off the gas with a long hand. “We’ll probably get arrested; my
muffler’s loose and liable to drop off.”
At Thirtyfourth Street they passed a girl riding slowly through the
traffic on a white horse; chestnut hair hung down in even faky waves
over the horse’s chalky rump and over the giltedged saddlecloth
where in green letters pointed with crimson read Danderine.
“Rings on her fingers,” chanted Stan pressing his buzzer, “And
bells on her toes, And she shall cure dandruff wherever it grows.”
II. Longlegged Jack of the Isthmus
N
oon on Union Square. Selling out. Must
vacate. WE HAVE MADE A TERRIBLE
MISTAKE. Kneeling on the dusty
asphalt little boys shine shoes lowshoes
tans buttonshoes oxfords. The sun shines
like a dandelion on the toe of each new-
shined shoe. Right this way buddy, mister
miss maam at the back of the store our new
line of fancy tweeds highest value lowest
price ... Gents, misses, ladies, cutrate ... WE
HAVE MADE A TERRIBLE MISTAKE. Must
vacate.
Noon sunlight spirals dimly into the
chopsuey joint. Muted music spirals
Hindustan. He eats fooyong, she eats
chowmein. They dance with their mouths
full, slim blue jumper squeezed to black slick
suit, peroxide curls against black slick hair.
Down Fourteenth Street, Glory Glory
comes the Army, striding lasses, Glory Glory
four abreast, the rotund shining, navy blue,
Salvation Army band.
Highest value, lowest price. Must vacate.
WE HAVE MADE A TERRIBLE MISTAKE.
Must vacate.
From Liverpool, British steamer Raleigh, Captain
Kettlewell; 933 bales, 881 boxes, 10 baskets, 8 packages
fabrics: 57 boxes, 89 bales, 18 baskets cotton thread: 156
bales felt: 4 bales asbestos: 100 sacks spools....
oe Harland stopped typing and looked up at the ceiling. The tips
J of his fingers were sore. The office smelled stalely of paste and
manifests and men in shirtsleeves. Through the open window he
could see a piece of the dun wall of an airshaft and a man with a
green eyeshade staring vacantly out of a window. The towheaded
officeboy set a note on the corner of his desk: Mr. Pollock will see
you at 5:10. A hard lump caught in his throat; he’s going to fire me.
His fingers started tapping again:
From Glasgow, Dutch steamer Delft, Captain Tromp; 200
bales, 123 boxes, 14 kegs....
Joe Harland roamed about the Battery till he found an empty seat
on a bench, then he let himself flop into it. The sun was drowning in
tumultuous saffron steam behind Jersey. Well that’s over. He sat a
long while staring at the sunset like at a picture in a dentist’s waiting
room. Great whorls of smoke from a passing tug curled up black and
scarlet against it. He sat staring at the sunset, waiting. That’s
eighteen dollars and fifty cents I had before, less six dollars for the
room, one dollar and eighty-four cents for laundry, and four dollars
and fifty cents I owe Charley, makes seven dollars and eighty-four
cents, eleven dollars and eighty four cents, twelve dollars and thirty-
four cents from eighteen dollars and fifty cents leaves me six dollars
and sixteen cents, three days to find another job if I go without
drinks. O God wont my luck ever turn; used to have good enough
luck in the old days. His knees were trembling, there was a sick
burning in the pit of his stomach.
A fine mess you’ve made of your life Joseph Harland. Forty-five
and no friends and not a cent to bless yourself with.
The sail of a catboat was a crimson triangle when it luffed a few
feet from the concrete walk. A young man and a young girl ducked
together as the slender boom swung across. They both were
bronzed with the sun and had yellow weather bleached hair. Joe
Harland gnawed his lip to keep back the tears as the catboat shrank
into the ruddy murk of the bay. By God I need a drink.
“Aint it a croime? Aint it a croime?” The man in the seat to the left
of him began to say over and over again. Joe Harland turned his

Advanced Macroeconomics 5th Edition Romer Solutions Manual Full Chapter PDF

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Advanced Macroeconomics 5th Edition

Romer Solutions Manual

(b) Average real money holdings are given by

Taking the natural log of both sides of equation (7) gives us

(a) The short-side rule implies that the level

(b) Since price inflation is given by

t1 to be g higher than it would have been since g is g higher than it

In period t + 1 we require  w t 1 to be g high since g is g

The same is true in each following period. Thus in this

Wage inflation in period t is given by

t1 be g higher. Since equation (14) holds

(b) Substituting the assumption that e = 0 into equation (3) gives us

(c) Differentiate both sides of equation (3) with respect to m to yield

See the figure at right. It is drawn for

Now suppose that inflation falls farther to  2  ~ .

(b) (i) The initial situation is depicted in the figure

Since y(0)  ~ y and the dynamics of inflation are ~

See the figures below.

(b) (ii) Since the initial value of inflation, (0), is

The initial level of output is less than the value that

(b) (iii) The initial value of inflation, (0), is less

Substituting equation (1) into (3) gives us

If we conjecture that the solution is of the form

then equation (4) becomes

Substituting equation (11) for output into the AS equation given by

When  < 1, [Kp*2 ]/f > 0 and Kp*2

Thus when  < 1, the incentive for a Km'2

When  > 1, [Kp*2 ]/f < 0 and

See the figure at right where the menu

In the case of  > 1, there can be a Kp*2

(b) The second-order Taylor approximation will be of the form

[21(y1, r*(y1)) + 22(y1, r*(y1))r* '(y1)][r* '(y1)] + 2(y1, r*(y1))[r* ''(y1)] –

Substituting equation (6) into equation (1) yields

(b) From equation (6), the variance of employment is given by

(c) (i) As stated in the problem:

(c) Solving for VP in equation (2) gives us

Substituting equation (3) into equation (1) yields

Substituting equation (15) into inequality (14) yields

(c) We are given that

(c) The aggregate price level is given by

The derivative in equation (19) is negative for m > Em.

immy Herf walked up four creaky flights and knocked at a white

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When  < 1, [Kp2 ]/f > 0 and Kp2

[21(y1, r(y1)) + 22(y1, r(y1))r* '(y1)][r* '(y1)] + 2(y1, r(y1))[r ''(y1)] –