Question

Question 1. (1) (6 points) Some economic historians have noted that during the period of the gold standard, gold discoveries were most likely to occur after a long deflation (for example, in 1896). Why might this be true (max 5 sentences)? You can assume that the price of gold against currency was fixed. Hint: The gold standard means that 1 HKD is exchanged with gold at a fixed rate. What does the long deflation mean about the value of gold relative to goods like oranges? Is the purchasing power of gold increasing/decreasing? What gives people strong incentive to discover gold? (2) (6 points) In the country of Lanlan, the velocity of money is constant and hence the quantity theory of money holds. Real GDP grows by 5 percent per year, money supply grows by 14 percent per year, and the nominal interest rate is 11 percent. What is the real interest rate? Hint: Assume the expected inflation rate is equal to the actual inflation rate and notice that i = r tre where i is the nominal interest rate and r is the real interest rate and n° is expected inflation.

Answer 1

1)1) When there is long deflation, then the gold discoveries are more likely. This is because deflation is the fall in price level.

This would mean that more goods would be bought with the given money. Now since the time is of gold standard, instead of money, more goods would be brought from given value of gold.

This would mean that each unit of gold would fetch additional goods and services which motivates or incentivises the people to discover gold. Also as said the more goods would be bought, so more amount of oranges would be available for a given unit of gold .

The purchasing power is increasing because with given level of gold more goods and services would be bought.

2) Inflation rate= Money stock growth - real gdp growth

Inflation rate= 14-5=9%

Real interest rate = Nominal interest rate - inflation

(Here it is assumed that expected and actual inflation is same)

Real interest rate= 11-9=2%

(You can comment for doubts)