Answer any TWO questions. Each question carries equal weight.

Transcription

1 UNIVERSITY OF EAST ANGLIA School of Economics Main Series UG Examination INTRODUCTORY MACROECONOMICS ECO-4006Y Time allowed: 2 hours Answer any TWO questions. Each question carries equal weight. Notes are not permitted in this examination. Do not turn over until you are told to do so by the Invigilator. ECO-4006Y Module Contact: Dr Odile Poulsen, ECO Copyright of the University of East Anglia Version 1

2 Page 2 1 This question focuses on an IS-LM short-term analysis. We use Y to denote income and r to denote the interest rate. a) Derive the LM relationship using algebra (equations) and a diagrammatic representation on the (Y,r) diagram. Provide economic intuition for the meaning of the LM relationship, describing all its features and the factors affecting the position and the slope of the LM curve. b) Consider the following information about the goods market and the money market, and calculate the equilibrium income (Y) and interest rate (r),. Illustrate this on the IS-LM diagram. C is consumption; I is investment; Ms is money supply; L1 is the transactions plus precautionary demand for money and L2 the speculative demand for money, G is government expenditure. Goods market: C = 0.25Y+180 I = -15r+100 G= 275 Money market: Ms = 284 L1 = 0.15Y L2 = -1.5r +200 c) Suppose that the Government promotes an expansionary fiscal policy, and address the following points: (i Describe briefly how the Describe briefly how the Government can implement the policy, providing two examples. (ii) Show the effects of the policy on the IS-LM diagram. (iii) Compare the two equilibria (before and after the policy) and discuss the process of adjustment of income to the new equilibrium; provide economic intuition. d) Suppose that, after the Government has implemented the expansionary fiscal policy, the Central Bank wants to return to the initial level of equilibrium income (before the expansionary fiscal policy): (i) Explain how the Central Bank can achieve its objective, providing examples of which policies can be promoted to do so. (ii) Show the implications of the Central Bank s policy on the IS-LM diagram. ECO-4006Y Version 1

3 Page 3 e) Discuss the effectiveness of monetary policy in relation to the features of the IS and the LM relationships. Under which circumstances is monetary policy more effective than fiscal policy at decreasing equilibrium income? Conduct your analysis making use of diagrams and economic intuition. 2 This question focuses on the ADI-ASI model and the Phillips Curve. a) Outline the fundamental assumptions and the features of the ADI-ASI model, and explain how this model is employed to conduct monetary policy. b) Write down the equation of the Taylor rule (TR) and describe all its components in detail. Explain how the Taylor rule is used to promote inflation targeting. c) Sketch a diagram with two Taylor relationships, one in which the Central Bank dislike inflation, and is willing to tolerate large output fluctuations to achieve its inflation target, (TR1) and one in which the Central Bank dislike large output fluctuation, and is willing to tolerate more inflation to achieve its output target, (TR2). With the aid of diagrammatic analysis: (i Discuss the effects of iscuss the effects of a fall in output in an economy where the Central fall in output in an economy where the Central Bank is characterised by (TR1), and when agents have adaptive expectations, and then analyse the effects of a contractionary fiscal policy in such a world. (ii) Discuss the effects of a fall in output in an economy where the Central Bank is characterised by (TR2), and when agents have adaptive expectations, and then analyse the effects of a contractionary fiscal policy in such a world. (iii) Comparing your answers to ( i ) and (ii) which TR generates the bigger change in output, and which TR generates the smaller change in inflation? Explain why this is the case. [20 marks] TURN OVER ECO-4006Y Version 1

4 Page 4 3 This question focuses on the features and implications of monetary policy. a) Explain the interest rate channel of monetary policy, providing an applied example. Explain why Central Bank independence from the fiscal policy maker matters, and evaluate whether or not Central bank independence is desirable. b) Discuss the difference between promoting expansionary monetary policy through a decrease in the interest rate or an increase in the money supply. Indicate the most effective method to increase equilibrium output, and give a reason to your answer. c) Discuss the effects of expansionary monetary policy on the price level, and on inflation, making use of both the AD-AS diagram and the Phillips Curve. Discuss how a government who dislikes inflation could counteract the action of an expansionary monetary policy? What tools does the government have at its disposal to prevent inflation from increasing in such a case? [20 marks] END OF PAPER ECO-4006Y Version 1

5 ECO-4006Y Introductory Macroeconomics Exam Feedback. Overall marks distribution: The spread of marks was a follows: 199 scripts were marked. The average was The standard deviation was There were 41 scripts that achieved a mark above 70. There were 52 scripts that achieved a mark between 60 and 69. There were 39 scripts that achieved a mark between 50 and 59. There were 34 scripts that achieved a mark between 40 and 49. There were 33 scripts that achieved a mark below 39. Feedback on Question 1: The total of marks that could be obtained was 50. The average for Question 1 was Question 1 part (a): The total of marks that could be obtained was 10. The average for this question was Question 1 part (b): The total of marks that could be obtained was 10. The average for this question was Question 1 part (c) part (i): Because there was a typo in the examination s script, every student who attempted to answer this question was awarded 2 out of 2. Question 1 part (c) part (ii): The total of marks that could be obtained was 4. The average for this question was 3.1. Question 1 part (c) part (iii): The total of marks that could be obtained was 4. The average for this question was Question 1 part (d) part (i): The total of marks that could be obtained was 5. The average for this question was Question 1 part (d) part (ii): The total of marks that could be obtained was 5. The average for this question was Question 1 part (e): The total of marks that could be obtained was 10. The average for this question was 4.48.

6 Feedback on Question 2: The total of marks that could be obtained was 50. The average for Question 2 was Question 2 part (a): The total of marks that could be obtained was 15. The average for this question was 6.26 Question 2 part (b): The total of marks that could be obtained was 15. The average for this question was Question 2 part (c) part (i): Because there was a typo in the examination s script, every student who attempted to answer this question was awarded 8 out of 8. Question 2 part (c) part (ii): The total of marks that could be obtained was 8. The average for this question was Question 2 part (c) part (iii): The total of marks that could be obtained was 4. The average for this question was Feedback on Question 3: The total of marks that could be obtained was 50. The average for Question 3 was 24. Question 3 part (a): The total of marks that could be obtained was 15. The average for this question was 5.89 Question 3 part (b): The total of marks that could be obtained was 15. The average for this question was Question 3 part (c): The total of marks that could be obtained was 20. The average for this question was 11. So overall students who chose Questions 1 and 2 performed better than students who chose Question 3.