ECO 209Y MACROECONOMIC THEORY AND POLICY

Transcription

1 Department of Economics Prof. Gustavo Indart University of Toronto February 14, 2014 ECO 209Y MACROECONOMIC THEORY AND POLICY Term Test # 3 LAST NAME FIRST NAME STUDENT NUMBER Indicate your section of the course: Monday, 2-4 L0101 Wednesday, 2-4 L0301 Tuesday, 2-4 L0201 Thursday, 2-4 L0401 INSTRUCTIONS: 1. The total time for this test is 1 hour and 45 minutes. 2. Aids allowed: a simple, non-programmable calculator. 3. Use pen instead of pencil. DO NOT WRITE IN THIS SPACE Part I /24 Part III 1. /10 Part II /21 2. /10 3. /10 TOTAL /75 Page 1 of 14

2 PART I (24 marks) Instructions: Enter your answer to each question in the table below. Table cells left blank will receive a zero mark for that question. Each correct answer is worth 3 marks. Note that no deductions will be made for incorrect answers Consider an open economy with a fixed price level, flexible exchange rates, and imperfect capital mobility. A decrease in the foreign interest rate would cause A) the domestic rate of interest to fall, equilibrium income to rise, and the balance in the current account to deteriorate. B) the domestic rate of interest to fall, equilibrium income to fall, and the balance in the current account to improve. C) the domestic rate of interest to rise, equilibrium income to rise, and the balance in the current account to improve. D) the domestic rate of interest to rise, equilibrium income to fall, and the balance in the current account to improve. E) the domestic rate of interest to fall, equilibrium income to fall, and the balance in the current account to deteriorate. 2. Consider an open economy with a fixed price level, flexible exchange rates, and imperfect capital mobility. If the government wishes to increase the rate of interest without affecting the value of the Canadian dollar, it should A) increase its spending and cut the money supply. B) lower its spending and cut the money supply. C) raise its spending and raise the money supply. D) lower its spending and raise the money supply. E) cut the money supply and leave spending unchanged. Use this space for rough work. Page 2 of 14

3 3. Under a system of imperfect capital mobility and flexible exchange rates, which of the following would be the most likely outcomes following the implementation of contractionary fiscal policy? A) Lower interest rates, currency depreciation, and improvement in the balance of the current account. B) Higher interest rates, currency depreciation, and improvement in the balance of the current account. C) Higher interest rates, currency appreciation, and deterioration in the balance of the current account. D) Lower interest rates, currency appreciation, and deterioration in the balance of the current account. E) Lower interest rates, currency appreciation, and improvement in the balance of the current account. 4. Consider a model of an open economy with a fixed price level, flexible exchange rates, and perfect capital mobility. Given an increase in autonomous exports, which one of the following statements is true? A) The domestic currency would appreciate, the rate of interest would rise, and the level of output would fall. B) The domestic currency would depreciate, the rate of interest would remain unchanged, and the level of output would rise. C) The domestic currency would depreciate, the rate of interest would rise, and the level of output would fall. D) The domestic currency would appreciate, but the rate of interest and the level of output would remain unchanged. E) None of the above are correct. 5. All else equal, if people decide to reduce the amount of currency they hold, A) the money multiplier will remain unchanged but money supply will fall. B) the monetary base and the money supply will both increase. C) the money multiplier will increase but the money supply will not change. D) the money multiplier will decrease and the money supply will fall. E) the money multiplier will increase but the monetary base will not change. Use this space for rough work. Page 3 of 14

4 6. Currency held by commercial banks is equal to $3 million, commercial banks deposits at the Central Bank are $7 million, the monetary base is $15 million, and deposits at the commercial banks are $25 million. The money multiplier is equal to A) 1.5. B) 2.0. C) 2.5. D) 3.0. E) none of the above. 7. Suppose that households desired currency-deposit ratio is 0.2 and the commercial banks desired cash-reserve ratio is 0.4. If the government borrows $100 million from the central bank to finance a new expenditure, the commercial banks loans to the public will A) increase by $100. B) decrease by $200. C) remain unchanged. D) increase by $200. E) increase by $ Greater income inequality has been identified as one possible cause of a weaker aggregate demand because A) high income households spend most of their income on luxury consumption goods. B) low income households are compelled to save more when their incomes fall. C) the marginal propensity to consume of high income households tends to be lower than the marginal propensity to consume of low income households. D) low income households tend to purchase more imported goods when their incomes fall. E) none of the above. Use this space for rough work. Page 4 of 14

5 PART II (21 marks) Consider a closed economy with fixed-price level and characterized by the following behavioural equations (all nominal monetary values are in millions of dollars): C = YD L = Y 10 i I = i Y M = M 1 G = G 1 TA = 0.25 Y TR = 50 a) What are the equations for the IS and LM curves in this model? Show all your work. (4 marks) Page 5 of 14

6 b) As a function of G 1, M 1 and P, what is the value of Y at which the goods market and the money market are simultaneously in equilibrium? Show all your work. (2 marks) c) What are the values of the fiscal policy multiplier ( FP ) and the monetary policy multiplier ( MP )? Show all your work. (3 marks) Page 6 of 14

7 d) If G 1 = 300 and M 1 = 200, what is the equation for the aggregate demand (AD) curve? [Note: Here you can write either Y as a function of P or P as a function of Y.] (2 marks) What is the real value of the quantity demanded of goods and services when P = 1? Show all your work. (2 marks) e) Consider the AD curve derived in part d) above. Suppose the government increases its purchases of goods and services by 50 and finances this new expenditure by borrowing from the public. What will be now the real value of the quantity demanded of goods and services when P = 1? Show all your work. (3 marks) Page 7 of 14

8 f) Consider the AD curve derived in part d) above and suppose that the public s desired currency-deposit ratio (cu) is 0.2 and the commercial banks desired reserve ratio (re) is 0.1. If the government increases its purchases of goods and services by 50 but finances this new expenditure by borrowing from the central bank (rather than from the public). What will be now the real value of the quantity demanded of goods and services when P = 1? Show all your work. (5 marks) Page 8 of 14

9 PART III (30 marks) Instructions: Answer the following three questions in the space provided (you may also write on the back of the page if needed). Each question is worth 10 marks. 1. Critically evaluate the following statement: An increase in autonomous exports will cause equilibrium income to increase, the rate of interest to rise, the exchange rate to depreciate, and the balance in the current account to improve. (Show your answer graphically and explain the economics. Consider the fixed-price model of an open economy with flexible exchange rates and no capital mobility. Assume that there is initially a recessionary gap in the economy.) Page 9 of 14

10 If needed, use this space to complete your answer to Question 1, Part III. Page 10 of 14

11 2. Critically evaluate the following statement: Expansionary fiscal policy will cause equilibrium income to increase, the rate of interest to rise, the exchange rate to appreciate, the balance in the current account to improve, and the balance in the capital account to deteriorate. (Show your answer graphically and explain the economics. Consider the fixed-price model of an open economy with flexible exchange rates and imperfect capital mobility. Assume that there is initially a recessionary gap in the economy.) Page 11 of 14

12 If needed, use this space to complete your answer to Question 2, Part III. Page 12 of 14

13 3. Critically evaluate the following statement: Although the Canadian dollar appreciated from a value of US$0.63 in January 2003 to a value of US$1.01 in January 2013, neither was Canada experiencing the so-called Dutch disease during this time nor was the loonie overvalued by early Moreover, any attempt to reduce the appreciation of the currency would have made matters worse by increasing the rate of inflation. Page 13 of 14

14 If needed, use this space to complete your answer to Question 3, Part III. Page 14 of 14