Examen de Introducció a la Macroeconomia UPF 2018 · Final Exam - April 2018

Labor market, Phillips Curve, and IS-LM-PC model

Carefully analyze the article published in The New York Times (February 2018) under the headline “The Stock Market Is Worried About Inflation. Should It Be?” and answer the questions below.

Part 1 - Question 1 (0.5 points). Reserve ratio cut in China

Consider the following excerpt from Bloomberg (June 2014), entitled "China's reserve ratio cuts extended to industrial bank":

"China's central bank extended a reserve-requirement cut to some national lenders including China Merchants Bank Co. and Industrial Bank Co. as officials try to support growth..."

Examine the rationale for lowering the reserve requirement imposed on commercial banks and outline the expected macroeconomic effects that policymakers aim to achieve through this measure.

Labor market, Phillips Curve, and IS-LM-PC model

Carefully analyze the article published in The New York Times (February 2018) under the headline “The Stock Market Is Worried About Inflation. Should It Be?” and answer the questions below.

a. Formulate the analytical equations for wage setting (WS) and price setting (PS), assuming labor productivity $A = 1$. Explain clearly how each relation formalizes the mechanism described in the excerpt.

b. Illustrate both relations in a diagram with real wage on the vertical axis and unemployment rate on the horizontal axis. Interpret the equilibrium point determined by their intersection.

Labor market, Phillips Curve, and IS-LM-PC model

Carefully analyze the article published in The New York Times (February 2018) under the headline “The Stock Market Is Worried About Inflation. Should It Be?” and answer the questions below.

b. Consider the section stating:

"That basic relationship between unemployment and inflation is known as the Phillips Curve. It did a pretty good job explaining inflation trends from the 1950s to the 1980s"

Contrast the empirical relationship documented in the 1950s–1960s with the breakdown observed during the 1970s and 1980s. Detail why the original trade-off vanished and how expectations changed.

Labor market, Phillips Curve, and IS-LM-PC model

Carefully analyze the article published in The New York Times (February 2018) under the headline “The Stock Market Is Worried About Inflation. Should It Be?” and answer the questions below.

c. Consider the excerpt:

"The unemployment rate is already low, and the new tax cut may push economic growth even higher. Wall Street knows that if Fed officials think inflation is poised to exceed its 2 percent target, they will raise interest rates to try to stop that from happening."

a. Using the IS-LM-PC framework, show analytically and graphically how a tax reduction stimulates output beyond potential and impacts inflation. State the three structural equations of the model.

b. Use the IS-LM-PC framework to depict the policy response implemented by the Federal Reserve to avert an acceleration in inflation.

Labor market, Phillips Curve, and IS-LM-PC model

Carefully analyze the article published in The New York Times (February 2018) under the headline “The Stock Market Is Worried About Inflation. Should It Be?” and answer the questions below.

Part 1 - Question 3 (1.5 points). Solow growth model and technological progress

Consider an economy characterized by a constant savings rate $s = 0.20$ ($20\%$) and a capital depreciation rate $\delta = 0.10$ ($10\%$). The aggregate production function is:

$$Y_t = F(K_t, N_t) = K_t^{0.5} N_t^{0.5}$$

Government purchases and taxes are zero, there is no technological change initially, and the labor force $N$ remains constant.

a.

Derive the law of motion for capital per worker between year $t$ and $t + 1$. State the condition required for the steady state, write down the corresponding equilibrium equation, and compute the steady-state values of capital per worker ($K^*/N$), output per worker ($Y^*/N$), and consumption per worker ($C^*/N$).

b.

Suppose the economy has attained its steady state. In year 2020, a technological breakthrough permanently updates the aggregate production function to:

$$Y_t = F(K_t, N_t) = 2 K_t^{0.5} N_t^{0.5}$$

Compute capital per worker, output per worker, investment per worker, and consumption per worker in year 2021.

c.

Determine the new steady-state values of capital, output, and consumption per worker under this enhanced technology. Describe the graphical representation of this adjustment process and explain how the transition unfolds starting from the 2021 dynamic values computed in 3.2.

Part 2

Part 2 - Question 1 (0.25 points). Real and nominal GDP growth and inflation

Consider the data in the table below and assume 2005 is the base year for computing real GDP:

Year

Quantity of cars

Price of cars

2004

10

€20,000

2005

12

€24,000

2006

13

€26,000

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Part 2 - Question 2 (0.25 points). CPI versus GDP deflator

If in an economy the inflation measured by the CPI was higher than that of the GDP deflator, this could be caused by:

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Part 2 - Question 3 (0.25 points). Discouraged workers and labor force

During prolonged recessions, it is difficult to get jobs and many workers become discouraged. Discouraged workers:

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Part 2 - Question 4 (0.25 points). Labor market reform and marginal propensity to consume

Suppose that in a given country a labour market reform, which decreases employment protection, decreases confidence about future income:

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Part 2 - Question 5 (0.25 points). Central bank money demand vs overall money demand

Choose the correct statement:

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Part 2 - Question 6 (0.25 points). Interest rate sensitivity of money demand

In money market, if economic agents demanding money are not very sensitive (so not react much) to changes in interest rate:

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Part 2 - Question 7 [0.25 points]. Fiscal contraction in medium-run equilibrium

Consider an economy in medium run equilibrium, where its output is equal to its potential output. If $G$ (government expenditures) decreases, how must the Central Bank change the real policy interest rate to maintain the existing medium-run equilibrium?

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Part 2 - Question 8 [0.25 points]. IS-LM equilibrium vs medium-run equilibrium

In the IS-LM-PC model:

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Part 2 - Question 9 [0.25 points]. Balance of payments accounting relation

In an economy without statistical discrepancy in its balance of payments we know that:

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Part 2 - Question 10 (0.25 points). Uncovered interest parity condition

Consider Japan and the US. Assume that between these two countries the interest parity condition holds. Choose the statement that is true (approximately):

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Part 2 - Question 11 (0.25 points). Real exchange rate and nominal appreciation

Assume that the nominal exchange rate of the euro (defined as quantity of foreign currency per €) increases by 5%. If prices (both domestic and foreign) do not change, we know that:

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Part 2 - Question 12 (0.25 points). Competition in product markets and price setting

Suppose an economy that experiences a decrease in the barriers to international trade, which makes its product markets more competitive. We will observe:

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Part 2 - Question 13 (0.25 points). Determinants of unemployment duration

The duration of unemployment will be larger:

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Part 2 - Question 14 (0.25 points). Unemployment below natural rate in Phillips curve

Based on the Phillips curve, if the unemployment level is below its natural level, which of the following is always true:

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Part 2 - Question 15 (0.25 points). Wage indexation and inflation response

Consider an economy where some wage contracts are set according to wage indexation:

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Part 2 - Question 16 (0.25 points). Factors influencing risky bond interest rates

Which of the following is likely to affect the interest rate paid by risky bonds?

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Part 2 - Question 17 (0.25 points). Risk premium shock in IS-LM model

Consider the IS-LM model. Assume the central bank chooses the real interest rate (i.e. the LM curve is flat). An increase in the risk premium paid on bonds will produce, in the short-run, which of the following?

Part 2

Part 2 - Question 18 (0.25 points). Asset decline and bank leverage ratio

Consider a bank with a total of 160 million dollars of assets, 140 million dollars of liabilities, and 20 million dollars of capital. If the value of the bank's assets decline by 10 million dollars:

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Part 2 - Question 19 (0.25 points). Characteristics of a balanced growth path

Which of the following is always true when an economy is on a "balanced" growth path?

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Part 2 - Question 20 (0.25 points). Solow model predictions with technological progress

In Spain, the rate of growth of output per worker from 1985-2014 was 1%, while the rate of technological progress in the same period was 0.3%. According to the Solow model, which of the following is true?

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