Macroeconomics A European Text 7th Edition Michael Burda ,Charles Wyplosz - Solutions

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(Section 1.1) What factors do you think explain why the United States is so rich and Bangladesh is so poor? What do you think accounts for the growth that most economies have shown?
Quotasand votingrightsat theIMF werechanged inApril 2008. The decision is presented in http://www.imf.org. Howwould you evaluatethischange?
Thechoice ofan exchangerateregimeis difficult. TheEuropeanMonetary Union combines fixed exchangeratesamongits members with afloatingexchangerate vis-à-vis therest of theworld. Explain howthis mixture ofexchangerates regimes works. Is it a good ora bad idea?
Isareturn to the gold standard feasible?Desirable?
It has been said that theBretton Woods systemwas doomed fromits start. Explainwhy. Could its demise have been avoided?How?
The poorercountries regularly proposethat theIMF issuemore SDRsand that they be distributedmostly to the poorercountries to support their development. Therichercountries refuse,contendingthat this would beinflationary. Discuss.
What is the difference between acurrency board andmonetary unionmembership?
TheEurozonecountriescannot borrowin their own currencies. This puts themat permanent risk ofafinancialcrisis.’ Explain and comment.
‘The developingcountriescannot borrowin their own currencies. This puts themat permanent risk ofacurrency crisis.’ Explain and comment.
Can self-fulfillingcrisesalso affect the bankingsystem?
Drawtheimplications of theN−1 problemfor theinternationalmonetary systemand for regionalexchangeratearrangements.
‘Currency crisescannot beforeseen, marketsattack as soon as they expect acrisis.’ Comment. In youranswer, youmay distinguish between first-generation and self-fulfillingcrises.
Does theHumemechanismworkwithin amonetary union?
China has been fightinghard to includeitscurrency in the SDR. What differencewill that make?
Does theTriffin Paradoxstillapply to theUSdollar?
Why can’t beggar-thy-neighbour policies work?What is the differencewith tariff wars?
Defineeconomicrent. Identify an economicrent that you find particularly objectionableand proposeways to eliminateit.
Taxesare distortionary but they are used to finance public goods. Howwould you appraisea proposal forseverely cuttingpublicservices in order to reducetaxdistortions?
Howwould you try to convinceworkers that they would globally benefit fromloweremployment protection?
Why do somecountries find it easier to carry out supply-sidereforms than others?
‘Acut in incometaxes in Europewould havesignificant supply-sideeffects.’ Comment.
Trace through the macroeconomic effects, in the short and long run, of a policy that reduces equilibrium output (for example, an increase in labour taxation). Under what conditionscould this lead to a permanent increasein therate of inflation?(Hint: usetheAD–ASframework developed in Chapter 14.)
What is the difference between activeand passivelabourmarket policies?
Showdiagrammatically howaleftward shift of thecollectivelaboursupply curvecan lead to along-run declinein output.
What isan unemployment trap?Howdoes it occur?Explainwhy workersat lower pay levelsaremorelikely to becaught in the unemployment trap.
It is sometimes claimed that overtimeworkingcontributes to the unemployment problem. In particular, hiringand firingcosts makeit moreattractiveto pay current workers to work more(theintensive margin) than to hire more workers (theextensive margin). Furthermore, tax provisions may shield
Chapter 15 discussed the‘Dutch disease’, thereaction of therealexchangerateto an increasein domestic wealth associated with aresource discovery. In thecase of Britain and Norway, both countries enjoyed the benefits of the North Sea oil discoveries of the 1970s. Norway subsidized its exporting
It is often alleged that the Laffercurveis morelikely to berelevant in countries with alarge underground economy. Explain. How might the underground economy contribute to the‘unemployment trap’ described in Box18.5?
Accordingto theRamsey principle of publicfinance(seeBox18.4), onwhichwould you levy higher taxes, jewellery or petrol?Labour income orcapital income?
Why iscuttingtaxes on capitalasupply-side policy?Why is it so controversial,especially in Europe?
Why aresupply-side policies bothmore promisingandmore difficult to implement than demand-side policies?
Debt stabilization iscontroversial. One viewis that it requires runningbalanced budgets, irrespective of the possiblecyclical implications. Another viewis that it is far better to usefiscal policy to support rapid growth. Evaluatethesearguments.
Between 2006 and 2010 theIrish public gross debt rosefrom37.8 to 96.2%of GDP. Collect data on Irish budgetsand growth duringthis period to explain this remarkableevolution (possiblesources:OECDEconomicOutlook database, Ireland’s FinanceMinistry’s website:).
Critics of the Stability andGrowth Pact arguethat it prevents the operation ofautomaticstabilizers duringcyclical downturns. The proponents respond that theway to dealwith the pact is to run structurally adjusted surpluses. Explain and comment.
‘The national debt isa great scam, becauseit will never berepaid.’ ‘The national debt is irrelevant becausewe oweit to ourselves.’ Comment on thesetwo popularcharacterizations of government indebtedness.
Makealist ofall publicservices that you can think of. In each case,examinewhether they can be privately provided.
Why doesa primary surplus in excess of what is found in (17.2) imply that the public debt willeventually disappear?Why doesa primary surplus in excess of what is found in (17.4) imply that the public debt willeventually disappearasafraction of GDP?
Consideracountry wherethe public debt standsat 60%of GDP. Thereal interest rateis 3%and thetrend growth rateis 2%. In theabsence ofseigniorage, what is the primary budget required to stabilizethe debt level?The debt–GDP ratio?
The budget balanceis –300 andGDP is 20,000. PotentialGDP, however, is 20,600. Computethestructurally adjusted budget usingthefollowinginformation:• publicconsumption is not cyclical;• transfersareas follows: TR= 13,000 − 0.5Y;• taxesare: T = 2,000 + 0.3Y.
Figure 17.5 determines four quadrants (ignoringthe diagonal). Characterizeand comment on thesituation in each quadrant.
What is the primary government budget surplus (asa percentage of GDP) that can stabilizethe debt–GDP ratio?(a) Howdoes youranswerchangeif theinterest ratefalls to 4%?If growth falls to 2%?
Supposethe debt–GDP ratio is 150%, growth is 3%perannum,and thereal interest rateis 5%.
Acountry growingat arate of 2%hasa debt–GDP ratio of 100%. What is the primary budget surplus that keeps this ratio constant when thereal interest rateis 2%?When it is 6%?
Acountry’s budget lawsets publicspendingat €30,000million and thetaxrateapplied to incomeis 25%. Last year’s GDP was €100,000million and theforecast is that it will grow by 3%. What is this year’s budget surplus (or deficit) set by thelaw? What will happen to the balance if theeconomy
Are bank notesand coins part of the public debt? Should they be?Why or why not?
Somecentral banks haveadopted negativeinterest rates. Why is it surprising and even counterintuitive?Imagine what could happen if they wereaiming at sharply negative rates such as–5%.
Recent bailout packages for the Greek economy haveimposed fiscal austerity measures (spending cuts and tax increases) on that country, which has traditionally run large budget deficits. Explain why theIS–TRmodelas wellas theAS–AD predict that theseausterity measures will lead to larger
Stateand critiquethe Friedman rulefor optimal inflation. Howmight theaccuracy of inflationmeasuresaffect yoursupport for this rule?
Can activist demandmanagement policiesaffect equilibriumunemployment?
‘Aggregate demand policy is based on exploitingmisperceptions of the privatesector in order to increaseGDP.’ Discuss.
Describethe non-standardmonetary policiesadopted in theaftermath of thefinancialcrisisand explainwhy they werejustified.
Why might theslope of the yield curve(long-termrate minus short rate) bea good predictor of the business cycle? How might it depend on the Taylor rulein force? How would it depend on theexchangerateregime?Drawwhat you think aBurns-Mitchell diagrammight look likeand explainwhy.
Namesomeleading, somelagging,and somecoincident indicators. Explain the behaviour of these variables, usingtheIS–TR–IFM andAS–ADframeworks.
Definethe Friedman critique ofactivist macroeconomic policy. What isan essentialelement for it to betrue?What could be done by governments to avoid it?
Now repeat your experiment, using a normally distributed randomvariablefor εt instead of thecoin flip (you will definitely need aspreadsheet for this). Plot your results.Howdo they compareto those of the previous problem?
Flip acoin 50 times, writingdown +1 for heads,−1 for tails (youmay useaspreadsheet programif you like). Call this variableεt. Now createa new variable, defined as yt =1/4εt −1+ 1/2εt + 1/4εt+1, so the new variableis aweighted average of present, past,and futurelagged values. (You will not
What arethecosts of inflation?Arethereany benefits of inflation?Ifso, what arethey?
How important is theslope of theAS curveforevaluatingtheeffectiveness of demand policy? What underlyingcharacteristics of theeconomy might contributeto asteeper AScurve?
Why is the behaviour of underlyinginflation so critical to evaluatingtheeffectiveness of policy? What determines this behaviour?Howdoes theexchangerateregime(fixed or flexible)affect youranswer?
Explain themotivation for Keynesian activist demand policy usinga diagram. Explain the neoclassical rejection of that type of policy.
Concern has been raised that the discovery and extraction of oil inKazakhstan and othercentralAsian countries might haveadverseeffects on theireconomies. What might be thereasons for theseconcerns?What effects would you predict the discoveries to have on therealexchangerateand thelong-termcurrent
Equations like(15.10)suggest that themarket must look at horizons so far out that they seemtomakelittlesense. Usethelogic of the yield curve, presented and explained in Chapter 7, to explain thesimilarity between thetwoways of reasoningand providean interpretation of howthemarkets think about the
‘The fact that currency crises can be self-fulfilling is greatly disturbing because it suggests that any country can see its money hugely devalued, for no good reason.’ In commentingon this statement,carefully establish the difference between self-fulfillingand other types ofcrises.
True or false: ‘Financial institutions tend to befor flexibleexchangerates, whilefirms in manufacturing and traded output in general tend to bein favour of fixed exchange rates.’
‘Theadvantage ofafixed exchangerateregimeis to greatly reduceexchangerate uncertainty.’ Comment.
Facingmarket pressureforan appreciation of the Swiss franc, the Swisscentral bank lowered its interest rate. Why?
‘Theequilibriumrealexchangerateremains constant when theactual realexchangerateremains durably closeto its equilibriumlevel.’ What is thelogic of such an assertion?Is thisalways true?
Figure 15.10 shows that Korea’s nominalexchangerate has considerably appreciated sincethe 1997–1998 crisis described in Section 15.8.2. What are possibleexplanations for thisappreciation?
Since 1970, Australia’s current account has almost always been in deficit, sometimes to a considerable extent. The real exchange rate has lost very little, some 10%. Is it surprising?Howcan this beexplained?
Within the euro area, interest rates on government bonds have become quite different recently. For instance, on 21 December 2011, interest rates on 10-year government bonds were: 3.35% in Germany, 8.23% in Ireland, 12.99% in Portugal, 6.74% in Italy, and 31.29% in Greece. Interpret these numbers.
to 2%) whiletheexchangerate between the Swiss francand theGermanmark first,and now theeuro, has remained stable. What does this mean for theinterest rate parity condition?Howcould you explain this phenomenon?
For decades, interest rates in Switzerland have been lower than inGermany (by
Supposethe Polish currency, thezloty (PLN), is trading at 0.225 EUR/PLN, and market participants anticipated that Poland would fix its exchangerateto the Euro in one yearat arate 0.25 Euro/PLN. What do you thinkwill happen to theexchangeratetoday?Howwould it help to knowinterest rates in Poland and
Consider thesameinterest rates as in the previous question. What would you do if you were 100% surethat theforint/euro exchangerate would remain constant, perhaps becausetherewasafixed exchangerateregime?Would this necessarily bea violation of the no-profit condition?Explain.
Theinterest rateinAustriais 3% whileit is 10% in Hungary. What does this imply for theforward premium/discount of theforint, the Hungarian currency, vis-à-vis the euro (which is used inAustria)?
Supposethat you could buy and sellUSdollars for $1.25/EURand pounds for 0.75£/EUR, but that at thesametimethe dollar–pound ratewas 1.65$/£.(a) What strategy would you pursueto takeadvantage of this ‘money pump’?What would bethelikely effect of themarket’s recognition of itsexistence?(b)
Suppose you are in charge of monetary policy in a developing country and the price of primary commodities (food, oil) rises sharply. What will be the consequence of pursuingaflexibleexchangerateregimewith afixed target rate of inflation?Arethere disadvantages to followingafixed exchangerateregime?
‘Sluggish expectationsare helpfulwhen inflation is risingbut troublesomewhen inflation is declining.’ Evaluatethisassertion and name possible policy implications.
Why aresupply-side policies moreappealingthan demand-side policies. What kind of policiescan you imaginewhichmight stimulatethesupply side of theeconomy?
Why doesaddingthesupply side partly underminethe usefulness of demandmanagement policies?
‘Expansionary demand policiesare based on foolingpeople.’ Comment.
Show under what condition the Taylor rule(14.7) implies that an increasein inflation leads to a higherexpost real interest rate, defined as i − π. Is this a desirablefeature of therule?Why or why not?
Central banks that adopt the inflation-targeting strategy usually publish forecasts of future inflation, thus implicitly or explicitly signalling what they plan to do in the future. It is argued that beingableto convincethe public of their intentions greatly enhances theeffectiveness ofcentral bank
Assume that underlying inflation is entirely forward-looking and that expectations are forward-looking and equivalent to perfect foresight. What are the effects of fiscal policy (under fixed exchangerates)andmonetary policy (under flexibleexchangerates) on output and inflation?Consider both cases
A government wants to use monetary policy under aflexibleexchangerateregimeto keep actual GDP aboveits trend growth ratefor ever. In the AS–AD diagram, show graphically theconsequences ofsuch a policy.
Tracetheeffects ofafavourablesupply shock, such asasudden declinein oil prices usingtheAS–AD framework. Supposethe government wants to takeadvantage of this event to bringabout a permanent decreasein inflation. Under which exchangerateregimeis this possible,and howcould the government achieveits
Under flexibleexchangerates, usetheIS–TR–IFM andAD–ASmodels to analysetheeffects ofan expansionary fiscal policy and tight monetary policy.
Under fixed exchangerates, usetheIS–TR–IFM andAD–ASmodels to analysetheeffects ofacombined tight fiscal policy and expansionary monetary policy.
UsetheAD–ASand IS–TR–IFM frameworks to study theshort-and long-run effects ofan increasein foreign inflation underafixed exchangerateregime.
Ifsupply shocks predominate, what can you predict about the direction ofco-movement between inflation and the output gap?If demand shocksaremoreimportant?Under which conditions would you expect to observea Phillipscurve?
Now consider an economy in a fixed exchange rate regime in which the output gap is positive—a booming economy—and domestic inflation exceeds foreign inflation.Describetheadjustment if thereis no intervention.
Consider theAD–ASmodel wheretheeconomy is not in long-run equilibrium, in particular assumethereis a negative output gap (that is, theeconomy is in arecession).Describetheadjustment under fixed exchangerates if thereis no government intervention. Contrast youranswer with that under
Consider thefollowingnumerical version of theAS–ADmodel:Assume the real interest rate is equal to 2, the target rate of inflation is 3, and s = 0. Use a spreadsheet or othercomputer programto characterize the steady state as a sequence of values of inflation, output,and interest rates which are
UsetheAS–ADmodel to study theshort-, medium-,and long-run effect ofa permanent decreasein theinflation target of thecentral bank.Assumethat underlyinginflation in thecurrent period is simply equal to inflation which is observed in the previous period. Contrast your answer with
UsetheAD–ASmodel to tracetheshort-run effect underafixed exchangerateregime of: (1)a one-off increasein taxes; (2)a one-off decreasein government spending; (3)a one-off decreasein animalspirits (Tobin’s q). What arethelong-run effects?
Under what conditionscould asharp depreciation only temporarily raiseinflation?
‘That thelong-run Phillipscurveis verticalmeans that governments should neverattempt to reduce unemployment with expansionary policies.’ Comment.
Why do someeconomists plead for policy measures that increasetheflexibility of wagesand prices?What can thecounter-arguments be?
Why is the battle of themark-ups important for understandingthe origins of inflation?Discuss thesignificance ofeach of theseassumptions: (1) imperfect ormonopolisticcompetition amongfirms; (2) labour unions orcollective bargaining; (3)constant labour productivity.
Imaginethat you are back in the 1960s, when the Phillipscurvewas believed to bestable. How, do you believe, were politiciansarguingabout whereit is best to be on thecurve?What mistakewould each side of the debate belikely tomake?

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