ANSWER ALL QUESTIONS CHAPTERS 6-9; 18-20 (Blanchard) Quesion 1 Discuss in deail he following: a) The sacrifice raio b) Okun s law c) The neuraliy of money d) Bargaining power e) NAIRU f) Wage indexaion g) Nominal and real exchange raes. Wha are a real appreciaion and a real depreciaion? i) The uncovered ineres pariy condiion? Wha does i imply in erms of he domesic ineres rae and he foreign ineres rae? j) The Marshall-Lerner condiion k) The demand for domesic goods and he domesic demand for goods. Which one is more relevan for he consrucion of he IS curve of an open economy? l) The J-Curve Quesion 2 Consider a wage-seing equaion of he form: W = P e F(u,z) where W sands for he aggregae nominal wage, P e for he expeced level of prices, u is he unemploymen rae, and z sands for oher facors ha may affec wages. a) Wha does his equaion say? b) Why does he price level affec wages? c) Why precisely he expeced price level? d) Why does he unemploymen rae affec wages? Wha oher facors could affec he deerminaion of wages? 1
Quesion 3 Consider a price-seing equaion of he form P = (1+µ)W where P is he price of a uni of oupu, W is he aggregae nominal wage level, and µ is wha we call he markup of price over cos. a) Wha does his equaion say? b) Under wha condiions would P = W? Quesion 4 In a closed economy, here is dissaisfacion wih he ineres rae ha is deemed o be oo high. Two alernaive policies are suggesed. Policy A aims a decreasing governmen expendiures. Policy B wans o ry expansionary moneary policy. [Be precise abou he shor and medium-run effecs of boh policies as well as abou he dynamic adjusmen from he shor o he medium run. Use words and graphs.] a) Which of he wo policies will be successful in he shor-run? b) Which of he wo policies will be successful in he medium run? c) Which of he wo policies aains higher oupu and higher invesmen in he medium run? 2
Quesion 5 Assume a (closed) economy is in is medium-run equilibrium, i.e. Y is naural oupu Y n. The governmen wans o achieve higher oupu and increases G. a) Using an AS-AD diagram, explain wha happens in he shor run. Is he fiscal expansion successful? b) Using he AS-AD diagram, explain wha happens in he medium run. Is he fiscal expansion successful in he medium run? c) Compare he new and he old medium-run equilibrium (he one before and afer he expansion episode). Are hey exacly he same or are here differences? In paricular, wha happened o C and I? Quesion 6 Using he AS-AD model, describe he impac of he following shocks in boh he shorrun and medium-run. In your diagrams show he equilibrium for he firs wo periods and he final medium-run equilibrium. Also, describe he impac of he shocks on C, I and G in boh he shor-run and he medium-run. Assume iniially ha he economy was a he naural rae of oupu. (a) An increase in he nominal money supply (b) The imposiion of a minimum-wage by he governmen (hin: how does his affec he labour marke) 3
Quesion 7 A governmen is considering he following policies: 1) A increase in governmen spending 2) An decrease in governmen spending 3) A increase in he nominal money supply 4) A increase in unemploymen benefis Which of hese policies would you recommend in order o achieve he following objecives: a) A shor-run decrease in he budge defici and a medium-run increase in invesmen b) An increase in he medium-run level of oupu c) A decrease in he price level, whils mainaining a balanced budge Show using diagrams and explain in words he shor and medium run impac of your chosen policies on Y, i, P, I, C and u. (obviously he policieis / policy objecives could be changed). 4
Quesion 8 e e Consider he following relaionship: π π = ( µ + z) αu, where π θπ π = Inflaion rae in year e π = Expeced inflaion rae in year µ = he mark-up parameer = 1. z = a cach-all variable ha reflecs insiuional facors ha affec wage deerminaion u = he unemploymen rae in year θ relaes las year s inflaion rae on his year s expeced inflaion rae. Making explici use of he above noaion, please define and explain he following conceps: a) The original Phillips curve b) The modified Phillips curve (or expecaions-augmened Phillips curve) c) Naural unemploymen rae d) NAIRU (nonacceleraing inflaion rae of unemploymen) 5
Quesion 9 Suppose ha he economy can be described by he following hree equaions: u u = 0.4( g 3%) Okun s law 1 y π π = ( u 5%) Phillip s curve 1 g = π Aggregae demand y g m a. Reduce he hree equaions o wo by subsiuing g y from he aggregae demand equaion ino Okun s law. Asume iniially ha u = = 5 1 %, g = 13%, and π = 10%, Now suppose ha u his year s money growh is permanenly reduced from 13% o 0%. b. Compue he impac on unemploymen and inflaion his year and nex year. c. Compue he values of unemploymen and inflaion in he medium run. m 6
Quesion 10 (a) A European counry s labor marke is characerized by he following wo equaions: P = W ( 1+ µ ) (Price seing by firms) e 1 0.5u + z W = P (Wage seing by workers) 1.06 The level of he markup is µ = 6%, while he value of he cach-all variable z is 0.04. Find he naural unemploymen rae, u n, for his economy. (b) The European counry of quesion 3(a) above has been in is medium-run equilibrium during he pas 3 years. The counry has a remarkably high normal growh rae of oupu, g y = 4%. For his reason, he EU parliamen has decided o allow his counry o ener he EU saring from he 1 s of January 2007, despie ha, in is medium-run equilibrium he inflaion rae has been 6% (including year 2006, so π 2006 = 6% ). Ye, he European Cenral Bank (ECB), concerned abou he requiremens of he Maasrich Treay, asks he Cenral Bank of he newly enering counry o se is growh rae of he money supply o 6% for he year 2007 (so he requiremen is ha g m, 2007 = 6% ). The counry s economy can be described by he following equaions: u u = 0. g g (Okun's Law) 1 5 y, ( ) ( u u ) π π = 0. 5 (Phillips curve) y 1 n y, = g m, π (Aggregae Demand Relaion) g Keeping in mind ha in year 2006 he economy was in is medium-run equilibrium, calculae he inflaion rae in year 2007 for his counry, afer seing g 6%, as he m, 2007 = ECB requesed. Will he counry ge closer o he inflaion requiremens of he Maasrich Treay in year 2007? (Hin: use your calculaions in quesion 3(a) above for he naural rae of unemploymen. If you have no solved 3(a), show he reasoning you would follow if you had u n.) 7
Quesion 11 Suppose ha you are advising a governmen ha wans o reduce is inflaion rae. I is considering wo opions: a gradual reducion over several years and an immediae reducion. a. Lay ou he argumens for and agains each opion. b. If he only crierion you were o consider was he sacrifice raio, which opion would you ake? Why migh you wan o consider oher crieria? c. Wha paricular feaures of he economy migh you wan o look a before giving your advice? Quesion 12 (a) Suppose ha he uncovered ineres pariy condiion holds and he expeced exchange rae beween he euro and he dollar in one year is 1.30 ( 1 = $1.30). Using he exac formula, deermine he curren exchange rae for he following pairs of annual ineres raes: i. Euro area, 8%; USA, 6% ii. Euro area, 7%; USA, 7% (b) Assume he following; (i) The ineres rae in he Euro area is 8%; (ii) The ineres rae in Japan is 2%; (iii) The curren nominal exchange rae is 155 ( 1 = 155 Yen); (iv) The expeced nominal exchange rae nex year is 135. Using he informaion above answer he following quesions, (i) How many Euro would an Ausrian residen expec o earn for each Euro invesed in Japanese bonds for one year? (ii) Ignoring risk and ransacion coss, should an Ausrian residen prefer o inves in Euro-area or Japanese bonds? (iii) Wha is he expeced rae of appreciaion or depreciaion of he Euro? (Sae which). (iv) Using he approximaion formula, show wheher he daa are consisen wih uncovered ineres pariy. If he daa are no consisen wih uncovered ineres pariy calculae he approximae value of he nominal exchange rae nex year consisen wih uncovered ineres pariy. 8
Quesion 13 Consider an open economy wih flexible exchange raes. The governmen is concerned abou he high rade defici and is planning o use fiscal policy o decrease i. Assume ha prices, oupu in he foreign economy, axes, governmen expendiures and expecaions on he fuure exchange rae are exogenous. Would you recommend he governmen o run an expansive or a conracionary fiscal policy? Explain graphically and verbally he consequences of each one of hem in erms of he effec hey have on: (a) (b) (c) (d) oupu, invesmen, he exchange rae, ne expors. Assume ha insead of using fiscal policy, he moneary auhoriies decide o increase money supply. Which effec will i have on he exchange rae? And on ne expors? 9