Macroeconomics: Questions and Answers

ECON1016 Group Work Assessment
PROBLEM
SET NO 4 (Chapter 30&33)
Student #1 Name and ID: Gwee Yi Xuan S3506518, 10148285
Student #2 Name and ID: Cheah Wei Yun, S3509385, 10148653
Student #3 Name and ID: Yong Chang Wei Stanley, S3532641, 10154582
Question 1
Suppose that a country’s inflation rate increase sharply. Explain the following situations. (1 mark for each)
a) What happens to the inflation tax on the holders of money?
As inflation rate increases sharply, the price level also increases sharply, causing the real value of money that the holders have to decrease.
b) Why is wealth that is held in savings account not subject to a change in the inflation tax?
Due to the Fisher effect, the bank has already taken inflation rate into consideration. For example, if the bank posts a nominal interest rate of 7%, and the inflation rate is 3%, the real value of the deposits grows by 4% per year. The wealth that is held in savings account is not physical cash due to the money multiplier, thus the value of this money does not decrease. It is not a real variable, according to the monetary neutrality.
Nominal interest rate = Real interest rate + Inflation rate

1

Question 2
Suppose that Australian expect inflation to equal 6 per cent in 2015, but in fact price rise by only 3 per cent. How would this unexpectedly low inflation rate help or hurt the following? (0.5 mark for each)
a) The federal government
This unexpectedly low inflation will hurt the federal government due to collecting a lower tax revenue. This may lead to the government printing more money to pay for their spendings. b) A homeowner with a fixed-rate mortgage
This unexpectedly low inflation will help the homeowner with a fixed-rate mortgage as it meant that they pay less for the real interest rate, assuming that the nominal interest remain constant.
Real interest rate (↓) = Nominal interest rate - Inflation rate (↑)
c) A worker with a 5-years fixed term wage contract
This unexpectedly