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foundations macroeconomics
Macroeconomics Imperfections Institutions And Policies 1st Edition Wendy Carlin, David Soskice - Solutions
Compare the adjustment to medium-run equilibrium after a fiscal contraction of a fixed and flexible exchange rate economy. What happens in the short run and during the adjustment to the medium run? Compare your results with the closed economy case.
How does inflation behave when the economy is not at a constant inflation equilibrium?
What determines the constant rate of inflation at a medium-run equilibrium?
What determines the unemployment rate at which inflation is constant?
Why might a medium-run position of stable inflation but trade imbalance be unsustainable in the long run?
What factors influence the rate of unemployment and output level that can be sustained in the medium run without problems of inflation?
What determines the level of output and employment in the short run?
A new government is elected and as a consequence the country is considered to be less risky. (a) Explain what is meant by Jess risky'? (b) Would you expect this to have a positive or negative impact on output in the short run in a fixed exchange rate economy and a flexible exchange rate economy?
Consider two economies: the home country is Norway (currency is the Krone), and the foreign country is the USA. State the uncovered interest parity condition, assuming that the default risk is identical between the two countries. For cach of the scenarios discussed below, assume that initially the
Use the Mundell-Fleming model and assume perfect capital mobility. Suppose there is a fall in the world interest rate. (a) Does this have an expansionary or contractionary impact on output in a small open economy? (b) Does the trade balance improve or deteriorate? Explain your answer. Look at both
Find out what happened to the nominal interest rate set by the Federal Reserve in the USA and by the ECB in the eurozone, and to the $-euro exchange rate following 11 September 2001 (to the end of 2001) [plot the data]. See the resources below for sources of data and discussion. The relevant
Assume that wages, prices, and the exchange rate are fixed. (a) Will a fall in the budget deficit due to a cut in government spending always improve the trade balance? Explain your answer. (b) What is the impact on output and the trade balance of a balanced budget increase in government spending?
Tell steps how Sector financial balances
Explain the concept of exchange rate overshooting and develop two different examples using private sector shocks—in one of which the equilibrium adjustment of the exchange rate is an appreciation and in the other, the equilibrium adjustment is a depreciation.
'Devaluation cannot affect the trade deficit because the latter must equal the difference between investment and saving, and neither of these magnitudes is affected by the exchange rate.' What is wrong with this argument in the context of an open economy with sticky prices?
Suppose that there is less than perfect capital mobility. Explain why in the interest rate-output diagram the $$i = \bar{i}$$ line is replaced by the balance of payments equilibrium condition: $$BT(i, y) + F(i) = 0$$. Why does this 'BP' curve in the interest rate-output diagram shift with a change
What assumptions must be made for the uncovered interest parity condition to hold? Explain what you would expect to happen to the domestic interest rate and the exchange rate in a small open economy following a rise in the demand for money, making clear the role of the UIP condition in this chain
What is meant by arbitrage in international financial markets? Give a numerical example to explain the concepts of the covered and uncovered interest parity conditions.
In an open economy, home residents can hold home or foreign bonds in their portfolio. What assumption allows us to write the demand for money in the open economy in the same way as in the closed economy, i.e. as a function of domestic output and the home nominal interest rate?
What would it mean to describe an economy as a 'small, open economy with imperfect capital mobility'; a 'large, open economy with perfect capital mobility'?
A small open economy has a government budget surplus and a trade deficit. Explain whether there is a private sector surplus, deficit, or balance. Examine the consequences in the short run for output, the trade balance, and the budget balance of a sudden fall in private consumption in this economy
Explain what is meant by the passage in italics in the statement that the Marshall-Lerner condition relates to the impact on the trade balance of a change in the real exchange rate, holding the level of output constant. Apart from the price elasticity of demand what extra information do you need to
Is the behaviour of the volume of exports a satisfactory measure of a country's competitiveness?
Explain the sense in which an improvement in price competitiveness might be considered a 'good thing' for the economy. Might it also be considered a 'bad thing'?
Explain two ways of measuring the real exchange rate. How well correlated would you expect them to be, and why?
What is the difference between the real and the nominal exchange rate? Give an example to explain this to a non-economist. Is an improvement in the terms of trade the same as an improvement in price competitiveness? Is an increase in the real cost of imports an improvement or a deterioration in the
How do fixed and flexible exchange rate regimes work?
What is the real exchange rate and how does it affect output and trade?
What determines the trade balance and why does it matter?
How is output determination in the short run affected by trade and financial openness?
In Japan, the price of real estate dropped dramatically in the late 1980s. Many Japanese firms have long-term relationships with a so-called main bank. How would you expect a deterioration of the balance sheets of Japanese firms and of their main banks to affect investment? Would you expect smaller
'Inflation targeting is a success but money supply targeting was a failure in the UK. Money supply targeting as a method of achieving low inflation was a success in Germany. Do you agree with these claims? What might account for these differences?
In the early 1990s in Russia, barter was widespread and there were billions of US dollars circulating. Why was the rouble not fulfilling its function as money? What costs did this impose on the Russian economy? [Reading: see the chapters by Seabright (2004) referred to in the chapter and references
How does the presence of asymmetric information affect macroeconomic outcomes?
In what ways did British experience in the early 1980s illustrate the problems with monetary targeting?
Why might the cash/deposit ratio and the reserve asset ratio be decreasing functions of the rate of interest? How does an interest-sensitive money supply affect the LM curve?Illustrate using an example, comparing the new LM with the standard LM.
What is the 'money multiplier'? What determines its size? What leverage does this give the central bank over the money supply?
What is a bull market? What is a bear market? How can the presence of 'market makers' explain their existence?
Compare the two broad explanations of bank runs. In particular, what is the underlying difference in the assumption about bank depositors' behaviour in the two approaches? What do you see as the main problems with these assumptions about their behaviour?
Why is the financial system heavily regulated?
Distinguish between adverse selection and moral hazard. Illustrate with examples.How have the concepts of asymmetric information and moral hazard affected our understanding of macroeconomics?
What is meant by 'internal' finance for investment and why may it be cheaper than'external' finance?
Imagine you are running a safehouse in the early nineteenth century. Assume there are 2,000 gold coins deposited with you and that you have issued these people with deposit notes. You have lent 1,800 gold coins. (a) Apart from lending money, what is the essential service that you provide? (b) What
The US economy went into recession in March 2001 and, in response, the government introduced a tax rebate programme which amounted to cheques of $300 or$600 in value being sent to about two-thirds of US households. The aim was to mitigate the recession. What would the consumption theories discussed
Examine how well the theories of investment presented in the chapter account for the fact that aggregate investment is procyclical.
There is widespread concern in the OECD economics about the inadequacy of (a) public pension arrangements and/or (b) private savings to provide adequately for retirement. Is this observation consistent with the models of consumption presented in this chapter?
Explain how you would expect a boom in asset prices to affect the macroeconomy.
Compare the investment function of Chapter 2 (I = A-br) with the investment function in section 2.5 (IA- bar+By). Why is the additional output term in the equation? How would the following affect the IS curve (ceteris paribus): (a) increased sales; (b) a change in competition law that will allow
What is the difference between 4 and Q? Under what assumptions is investment solely a function of q? Do empirical Q based investment models fail because these assumptions are invalid or because Q is a poor measure of q?
How does the introduction of adjustment costs and imperfect competition alter the modelling of investment?
What assumptions are required in order to derive the accelerator investment function? Why does investment take place according to this model?
Using the simple investment function: A br explain what happens to the IS curve if (a) profitability in the future is expected to be lower; (b) the real interest rate falls; (c) the future real interest rate is expected to fall.
This question relates to the consumption function presented in section 1.10. Suggest why the real interest rate may have a negative effect on consumption. Use an IS diagram to represent the consumption function and discuss how consumption and hence the IS curve responds (ceteris paribus) to, (a) a
Why may households not be able to borrow against the value of their future income?
Explain what is meant by the 'excess smoothness' of consumption and why it may characterize behaviour.
What is meant by the expression 'excess sensitivity of consumption? How do the assumptions of the simple PIH have to be amended to account for this finding?
What is meant by the term 'random walk'? Under what conditions will consumption follow such behaviour?
What is precautionary saving? What assumptions are needed for precautionary savings to arise? Does precautionary saving resolve some empirical puzzles in consumption behaviour?
Use the Discrete Time Ramsey equation and the Ramsey consumption function and explain what happens to the growth of consumption and to current consumption under the following circumstances: (a) a rise in the rate of interest; (b) the individual becomes more impatient; (c) the individual
Provide concise explanations in words for the results summarized in Table 7.1.
What is the relationship between the marginal and average propensity to consume in the standard Keynesian consumption function? In the permanent income hypothesis?
A study by the credit rating agency Standard and Poors entitled 'In the end we are all debt: aging societies and sovereign ratings' published in 2005 stated:'Notwithstanding the reform flurry of late, without further adjustment either to the current fiscal stance or to social security and health
What light does the analysis of debt dynamics and the prudent fiscal policy rule throw on the question of the appropriateness of common fiscal targets for the transition countries that have just joined the EU and other members?
Begin with the scenario in Fig. 6.4(a). Following the shift to an explosive debt path, assume that the debt ratio has risen further before the government reacts. If its objective is to return the debt ratio to its initial level, explain using a diagram how it could achieve this by using fiscal
Should fiscal policy be delegated to an independent authority? If so, should it be the same body that sets monetary policy? Discuss.
Under what circumstances might policy makers wish to reduce the ratio of public debt to GDP? What factors should influence the policy adopted to achieve such a reduction.
What role does seignorage play in creating and sustaining high inflation?Can you provide an explanation for why a rational government would allow high inflation? What about hyperinflation?
The Golden Rule is attractive because although it has some drawbacks, it is superior to an arbitrary x% deficit rule on economic grounds and is easy to explain to the public and to monitor.' Assess this statement.
Explain in words what is meant by the prudent fiscal policy rule. What is the main reason for 'tax smoothing'? Under this rule, how should a government react in the following scenarios: (a) defence spending is cut for the foreseeable future due to the end of the Cold War; (b) the government
Why is the level of the government debt ratio of any concern?
Countries have traditionally borrowed to finance war expenditure. Is this justified by economic reasoning?
What is meant by Ricardian equivalence? Does it imply that high public debt is no cause for concern? How would you test for its existence?
Assuming that households consider bonds to be net wealth, why does bond financing of government expenditure shift the IS curve further to the right than would otherwise be the case? Why does the LM curve shift to the left?
Why is it conceptually equivalent to the discretionary fiscal impulse? Is such a deficit sustainable?
Explain the logic of the balanced budget multiplier result. Investigate whether this result continues to hold if(a) the money supply is kept constant (rather than the interest rate);(b) there is a proportional income tax (rather than a lump sum tax).What is meant by the cyclically adjusted budget
What are the automatic stabilizers? How could the method of local government taxation affect the automatic stabilizers?
Select two out of the following central banks: Bank of England, Reserve Bank of New Zealand, Bank of Canada, and the Swedish Riksbank. Each of these central banks has adopted explicit 'inflation targeting'. For each of your chosen banks, find out how it explains what this means to the public. How
Using Fig. 5.8 as a guide, draw the corresponding diagram to illustrate the lag structure in the standard version of the 3-equation model. Now assume that there is no lag between a change in the interest rate and its effect on output. Draw a diagram to illustrate this lag structure. Use all three
Is there a trade-off between stabilizing inflation and stabilizing the real side of the economy? Explain.
Consider a Central Bank that maximizes the following utility function: Z-ky-ye)-(1)where k is a positive constant. Its policy instrument is the growth rate of the money supply, w. Assume that the inflation target is a = 0. Explain this utility function and compare it with the loss function used in
What are the incentives for a policy maker to exploit the short-run trade-off between unemployment and inflation? What are the consequences? Is this a good description of contemporary central bankers? Use official reports of a central bank of your choice to provide support for your argument.
Explain what is meant by the statement that a government that is determined to reduce inflation may have a problem in achieving this outcome because of a lack of credibility.
The central bank faces a short-run trade-off between inflation and unemployment (a) If inflation expectations are backward looking or (b) if inflation expectations are rational but are formed before the central bank chooses its optimal inflation-output pair. Explain each of these cases. What
Under what circumstances will a central bank utilizing an interest rate based monetary rule to stabilize the economy fail in its objective of raising output?
Write down the Taylor Rule in terms of the real interest rate. Holding the output gap constant, does a rise in inflation by x percentage points call for a rise in the nominal interest rate by more than, less than, or by just x percentage points? Explain.
In implementing a Taylor-type interest rate rule, does the central bank need to know anything more than the coefficients in the rule, its inflation target, and current output and inflation?
If a central bank adopts an interest-rate based monetary policy rule like a Taylor Rule rather than a monetary growth rate rule, what would you expect to happen to the money supply?
Suppose there are two regions of the country, in one of which the WS curve is quite steep and in the other, the WS is quite flat. Why might this be so? Compare the implications for inflation and unemployment of a common positive temporary aggregate demand shock. How should the central bank respond?
Compare the response of an inflation-targeting central bank to a permanent negative aggregate supply shock with that to a permanent negative aggregate demand shock.
How can the central bank diagnose what kind of shock has disturbed the economy?
Explain what is meant by the central bank's loss function. How are the central bank's preferences reflected in the loss function? Use a numerical example and diagrams to explain how the central bank's preferences affect its reaction to a negative aggregate demand shock.
What are the advantages and disadvantages of an inflation rate of 3% as compared with one of 0% per annum? Would you advocate the replacement of the inflation target by a price level target?
Declines in union density are often attributed to structural change, globalization, and demographic changes. Why might this be so? What would you expect the macroeconomic impact to be? [Suggested reading: Checchi and Lucifora (2002), Lesch (2004).]
In 1998, Robert Solow reported on a study by McKinsey Global Institute, which analysed the economic performance of France and Germany in terms of employment and productivity in six industries: automobiles, housebuilding, telecommunications, retail trade, consumer banking, and computer software.
'Unions and labour market regulation reflect the power of vested interests and create inefficiency.' Unions and labour market regulation are an efficient response to missing markets.' Investigate how economic theory can be used to support each of these lines of argument. Do you find either argument
How may unemployment be affected by (a) barriers to regional mobility; (b) poor information about jobs; (c) stronger employment protection legislation?
Through what mechanisms can hysteresis in unemployment operate? What are its consequences for the time-path of the unemployment rate following (a) a period of disinflation? (b) an investment boom?
Trace the effects on unemployment and inflation of a sudden and permanent rise in labour productivity due to a technological breakthrough.
Explain The Mundell-Flemìng model and fiscal policy
I Low, if at all, would you expect the internet to affect the WS, PS, or the Beveridge curve?
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