FinalAK-2006 - Economics 102 Macroeconomic Theory Csar M...

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Economics 102 Macroeconomic Theory Name: CØsar M. Serra Summer 2006 Student ID: Final Examination September 13th, 2006 Instructions. You have 120 minutes. Answer questions 1 to 6. Question 7 is a bonus question . Show your work since partial credit will be considered. If you need more space, write on the back and be explicit about the question being answered. Keep your answers as succinct as possible, the space given is enough to answer the questions. The exam is closed book/closed notes. You can use an electronic calculator. There are 100 points total plus 10 bonus points. De°nitions 1. Choose 4 out of 5 de°nitions (5 points each) (a) Consumption Smoothing. The fact that consumers prefer an even path of consumption across time. (b) Constant Returns to Scale. If inputs of production, capital and labor, are changed by a factor x, then also production changes by a factor x or xY=zF(xK,xL). (c) X is countercyclical. X moves over time in opposite direction to GDP, if GDP goes up (down) then X goes down (up). (d) Leading variable. A variable that helps predicting the future path of GDP or its peaks and troughs tend to precede those of GDP. (e) Lump-sum taxes. A °xed amount of taxes that does not depend on consumer±s decisions and that do not a/ect prices in the economy or taxes that do not distort relative prices in the economy. Readings 2. (15 points) Choose 1 out of 2 questions. (a) Ricardian Approach to Budget De°cits. What is the e/ect of a budget de°cit created by a reduction in taxes on a closed economy according to the Standard Model and the Ricardian View? Standard Model : If taxes are cut, then consumer±s disposable income Y d increases. The increase in Y d leads to higher current consumption and higher private savings. However, the increase in private savings do not o/set the reduction in government savings. Therefore, national savings decreases, the real interest rate increases, investment goes down and in the long-run the e/ect is re²ected on a lower stock of capital : Ricardian View : Given a certain path of government expenditure, a cut in taxes today with an equal and opposite change in the present value of taxation tomorrow does not a/ect current consumption. Private savings increases by the same amount government savings decreases, national savings is not a/ected and the real interest rate does not change. (b) Modern Macroeconomics in Practice. What do you understand by the Time Inconsistency Problem? What monetary policy proposals have been implemented or are being discussed to ameliorate this problem? The fact that optimal policies with commitment for the future are time inconsistent, namely, once the future arrives, the government would prefer to implement a new policy which is di/erent to the one committed years ago. Changing policies as the future arrives (discretionary policies) only brings bad results for the economy. That±s the reason of why rules (policies with commitment) are better than discretion (policies without commitment). Two monetary policy proposals aimed to ameliorate this problem are Central Bank independence and In²ation Targeting.
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