NAME: Econ 302 Mid-term 3

Transcription

1 NAME: Econ 302 Mid-term 3 Instructions: This exam consists of two parts. There are twenty multiple choice questions, each worth 2.5 points (totaling 50 points). The second part consists of 2 problems, also totaling 50 points. Please write clear answers that tell the examiner exactly what you want him/her to know. Make sure you write your name and student ID # on this exam. Good Luck! 1. A temporary increase in government spending crowds out: a) private consumption spending b) private investment spending c) permanent government consumption d) private consumption and private investment spending 2. For the government, is a source of revenue, while is a use of funds. a) transfer payments; issuing new money b) issuing new money, issuing new bonds c) taxes; purchases of government consumption goods d) interest payments on the public debt, transfer payments 3. Lump sum taxes cause effects. a) Do not; wealth b) do; wealth c) do; substitution d) both (b) and (c). 4. For a unit change in government spending, suppose consumption decreases α and output increases β. Now, suppose when government spending increases temporarily, you observe a decrease in the real interest rate. What must be true about the relationship between α and β? a) α + β = 0 b) α + β = 1 c) α + β < 1 d) α + β > 1 5. With an income tax of rate τ, someone who saves an extra dollar receives in the next period: a) 1 + R b) 1 + R-τ c) 1 + R(1-τ) d) None of the above.

2 6. The impact in the current period of a temporary increase in the marginal tax rate the after tax real interest rate and investment. a) raises; raises b) lowers; lowers c) raises; lowers d) lowers; raises 7. Which of the following is the best example of a flat rate tax in the United States? a) Social security tax b) Medicare tax c) Federal income tax d) State income tax 8. The Ricardian Equivalence Theorem effectively states that a) spending by the government is considered by the public as equivalent to its own spending b) the timing of taxes does not matter c) people view government issued bonds and money as equivalent d) none of the above. 9. An open market purchase of bonds for money by the government a) lowers the real interest rate and increases private investment b) decreases the level of output c) has no effect on the price level d) increases the price level but has no effect on real GDP 10. Suppose that Thailand has a large debt denominated in Thai Bhat. Can Thailand just print a whole bunch of Bhat to pay off this debt? If so, what happens to the number of Bhat that $1 can buy on the foreign exchange market? a) No way, and no answer is necessary for part two. b) Yes, number of Thai Bhat per U.S. Dollar decreases. c) Yes, number of Thai Bhat per U.S. Dollar stays the same. d) Yes, number of Thai Bhat per U.S. Dollar increases. 11. Suppose that Madison issues $1 million in debt to pay for a bigger football stadium. It plans on paying off this debt by making interest payments and rolling the debt forward every year. Interest rates are expected to be 0% per year, there s no inflation in Madison, Madisonian taxes are lump sum, and there are no government transfers. The nominal interest rate is expected to be 4% every year. The population of Madison is 1 million and expects to remain at that level forever. Each consumer in Madison will theoretically react in the same manner as if taxes: a) had been raised $1 dollar this year b) had been raised $.04 every year c) Neither a nor b d) Both a and b

3 12. Suppose a permanent negative shock to the production function affects one small country. That country s real interest rate will while its total expenditures on goods and services will. a) rise; fall b) not change; not change c) not change; fall d) none of the above 13. Suppose a permanent positive shock to the production function affects the entire world. Then in any small country, the real interest rate will while total expenditures on goods and services will. a) rise; fall b) not change; not change c) not change; fall d) none of the above 14. At time period 0, suppose that the rate of return on a 1-period bond is 14% in Germany, and 4% in the U.S. Further, suppose that at time period 0, the exchange rate is 2 German Marks / U.S. Dollar. All else equal, from what you know about purchasing power parity and interest rate parity, what would be reasonable expectations for you to have regarding the inflation rate in Germany and the U.S.? a) U.S. Inflation = 2%, German Inflation = 12% b) U.S. Inflation = 9%, German Inflation = -1% c) none of the above. d) both (a) and (b). 15. Suppose that the U.S. government consumption level rises temporarily by $10 billion. According to our model, how much would we expect private consumption to change by? a) C should go up, but less than $10 billion. b) C should go up exactly $10 billion. c) C should go down more than $10 billion. d) C should go down, since government is consuming more. 16. Interest rate parity implies that a) nominal interest rates in different countries are always equal b) countries with higher inflation rates will have lower nominal interest rates than countries with lower inflation rates c) the faster a country s exchange rate depreciates, the higher it its nominal interest rate d) none of the above 17. When a country devalues its exchange rate, it a) eliminates the flexibility in the exchange rate b) changes from fixed to flexible exchange rates c) lowers its fixed exchange rate d) raises its fixed exchange rate

4 18. An Econ PhD student has $1. He sees the following exchange rates on his Reuters terminal: Japanese Yen / U.S. Dollar = 300, British Pound / U.S. Dollar = 1, Japanese Yen / British Pound = 300. According to his macroeconomic analysis, he expects that the British Pound / U.S. Dollar rate will increase, but isn t totally sure. He d really like to make some money, since T.A.ing doesn t pay very much and he needs to buy an XBOX 360. Is there an arbitrage (risk-free profit) opportunity? If so, what is it? a) No way. The PhD student is stuck with his Super Nintendo, tough luck. b) Yes. Buy Yen with Dollars, then buy Pounds with Yen, then buy Dollars with Pounds. Repeat. c) Yes. Buy British Pounds. Wait until tomorrow, and hope that the Pound / Dollar rate rises. d) Yes. Buy Pounds with Dollars, then buy Yen with Pounds, then buy Dollars with Yen. Repeat. 19. In class, we learned about (absolute) purchasing power parity. Suppose I looked at the price (in foreign currency) of Big Macs across different countries, and then put those foreign currency prices into U.S. Dollar prices using spot currency prices. What would I expect to see according to (absolute) purchasing power parity? What would I really see? a) The prices of Big Macs in terms of U.S. Dollars should theoretically be the same The prices of Big Macs in terms of U.S. Dollars are in fact the same b) The prices of Big Macs in terms of U.S. Dollars should theoretically be different The prices of Big Macs in terms of U.S. Dollars are in fact the same c) The prices of Big Macs in terms of U.S. Dollars should theoretically be the same The prices of Big Macs in terms of U.S. Dollars are in fact different d) The prices of Big Macs in terms of U.S. Dollars should theoretically be different The prices of Big Macs in terms of U.S. Dollars are in fact different 20. The Ricardian Equivalence Theorem (as described in the text) relies on several assumptions. Which of these pairs of assumptions are important for deriving the Ricardian Equivalence Theorem? a) Everyone can borrow at the same real rate of interest, and the government never runs a deficit. b) People have convex preferences, and everyone can borrow at the same real rate of interest. c) People take account of events that will affect their children, and everyone can borrow at the same real rate of interest. d) People take account of events that will occur throughout the infinite future, and people have convex preferences.

5 Part 2: Answer the following three questions. 1. PPP and Interest Rate Parity: Derive the formulas for Purchasing power parity and Interest rate Parity in absolute form. Derive the IRP in relative form. Suppose that the return on domestic bonds held by foreigners in country i are taxed at the rate τ. Write down the interest parity condition (between countries i and j) as viewed by an investor in country j. (25 points)

6 2. Current Account Balance: The Current Account Balance is initially positive. Assume that a permanent positive shock to production affects a large country in an open economy. Assume that the shift increases the MPK. Draw two graphs indicating the short run and the long run responses. Be clear to indicate what happens to the real interest rate and the CA balance. Explain the intuition behind the graphs. (25 points)