ECON3020 Advanced Macroeconomics Semester 2, 2021
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Semester Two Final Examination, 2021
ECON3020 Advanced Macroeconomics
Question 1
You are given the following equations in the sticky price New Keynesian model that has been analysed in this course:
Ct = Cd (Yt Gt ,Yt +1Gt +1,rt ) Nt = NS (wt , θt )
Pt = Pt + γ (Yt Ytf )
It = Id (rt ,At+1,ft ,Kt )
Yt = At F (Kt ,Nt )
Yt = Ct + It + Gt
Mt = Pt Md (rt + π1,Yt )
rt = it π1
Based on the above information, answer the following questions:
(i) In this model in which direction would the IS curve shift with an anticipated increase in productivity at time t+1 ? Explain in terms of the variable(s) and equation(s) in the model.
[2 marks]
(ii) In which direction would the LM curve shift with an increase in the price level at time
t? Explain in terms of the variable(s) and equation(s) in the model.
[2 marks]
(iii) If (i) and (ii) were to occur simultaneously, explain the effect on the real interest rate
and aggregate demand.
[2 marks]
(iv) Explain the effect of the changes described in (iii) on output if prices are fully flexible.
[2 marks]
Question 2
Given the sticky price New Keynesian model in Question 1 above, answer the following questions:
(i) Suppose that the government implements an expansionary fiscal policy financed by selling bonds to the private sector. Suppose also that the central bank buys back the bonds from the private sector, thereby increasing the money supply.
Using diagrams, illustrate the effect of these policies on the IS,LM and AD curves.
[3 marks]
(ii) Explain the effect of the policies that you have illustrated in (i) of this question, on the
real wage.
[2 marks]
(iii) Explain and illustrate on a diagram(s) the effect of an increase in energy costs on
output, the real interest rate and the real wage. [Hint: an increase in energy costs increases the cost of producing output for any given level of labour and capital.]
[3 marks]
Question 3
Explain in detail the channels through which monetary policy is transmitted to aggregate demand.
[8 marks]
Question 4
Suppose that output and the price level are both at their target levels. Then suppose that an investment and consumption boom occurs. Explain the optimal monetary policy response, illustrating using diagrams representing the sticky price New Keynesian model.
Your answer should discuss the effects, before and after the monetary policy response, on the real interest rate, output, price level and real wage.
[8 marks]
Question 5
Consider the following Phillips curve data for OECD countries.
The figure above shows an apparent downward shift of the whole Phillips curve from one decade to the next, and also a flattening of the curve in the last decade. Hence inflation became lower and more stable for a given unemployment gap. (Note: the unemployment gap depends negatively on the output gap. When the output gap increases, the unemployment gap decreases. You can interpret the above graph as though the unemployment gap is simply the unemployment rate.)
Discuss, in terms of the sticky price New Keynesian model, what may have caused these changes.
[8 marks]
Question 6
(i) Discuss the implications of the so-called ‘zero lower bound’ on nominal interest rates for the effectiveness of fiscal policy.
[4 marks]
(ii) What monetary policy options does a central bank have when it faces a zero lower
bound on nominal interest rates? Explain.
[4 marks]
Question 7
Most advanced economies have experienced two major recessions over the past 20 years: first, the recession caused by the Global Financial Crisis (GFC) that began in 2008; and second, the recession caused by the COVID- 19 pandemic that began in 2019.
Compare and contrast the causes and effects of these recessions in terms of aggregate demand, aggregate supply, the real interest rate and the general price level of goods and services. Illustrate with appropriate diagrams.
[8 marks]
Question 8
This is optional and not included in the 5 questions that you must answer.
Specify any assumptions you have made in completing the exam and to which questions those assumptions relate. You may also include queries you may have made with respect to a particular question, should you have been able to ‘raise your hand’ in an examination room.
[No marks]
2022-11-16