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Unformatted text preview: ' QUESTION 1 ,(10 pants); 7 , 37 [The'just elected president of Uruguay, hires to advice on eitchange rate? ' “ system to adopt; Uruguay is’ a small, open economy,
' from the. international capital markets.__", « (5 points) In order to reduce. the velatility’of the exchanger’ategthe newgOVernment I ‘ 91} _ , .ithhinking of adopting a ﬁxed exchange rate system; This decrease in uncertainty _ ‘_ ._ : ' . ' g 3 I
, _ could potentially enhance the ,conﬁdenCe oftforeigninvestors when decidingto invest g; _ ,. “ ‘ ‘ 3i in Uruguay. As an eXpert in the Smallopen‘emnomy ISLM model,tyou know that a r i" drawback of a ﬁxed eXchange rate is thatithe/gOVe‘mmmt loses control'onone of its * i i * Policy variablesteitherﬁ; T OngS) t0 ‘ﬁféci the OPtPEtltYel " ' ‘ is the ‘ 7 Explain conclusion ' I;
I clear about'the effects on the interest rate; CapitalﬂoxVS; and, exchange’ratet (Notef in __ V; "f equilibrium); ‘ movement in the IS LM curves and the resulting equilibrium ﬁfom; this policy. Be ,_ ‘ panels A andB,» rt isthe international interest rate. andEO denotes the initial l’ ; L the small open economy ISLM model; You know that one of the jeXchange rate _, : i. 5 . ' " i regimesyou Studied in (:11 canavoid a recessionaﬁerafall in H "7" : ‘ eXCliange rate system delivers the'ineffectivenessof ﬁscal policy onioutput‘k?‘ ’ ' L ‘ Explain hon? you reached, this conclusion in Panel B, shoWingthemovement in the IS and LM curves and there‘sulting ‘ L “ effects on the interest rate, capitaltﬂows, and eXchangje rate. I ' ' a , a .7; I ‘a'ywould the exchange rate afterthe'decrease i
. [compared to the initial eqmlibriumiyi, ; . ;_~ n "  ~ twihich' takes the interest rate as given V , , ,y f ‘ policythameaatnsawaits ' ‘
* ' (Sipoi‘nts) The preSident to reduce the budget; deﬁcit the L, i L L
next years byreduCing thenumber of public employees. However, he wants to avoid _ L '_ ‘ gcausing a recession as a result of this contractioiiary ﬁscal policy moveAgain; using g _ . I j _ equilibrium ﬁromthispolyicy. Be clear about the V r l, 7 f. . ‘ QUESTiON 2‘ (20 points) : __ t ‘y ‘sCOnSider an ebonotny with the following SP relationship _ '
* p=p¢+0.'5 '+z ' where p andee are actualand expected rates, of inﬂation, )7 is the'log output ratio'_(whei'e _‘ , Y =100*1n[Y/Y N] where YN is thenatural rate of real output) and z is a supply shOck. I 7 i I Assume that thenatural rate: of realloutput‘ growth" giszero, so that nominal GDP growth is r ’ , the same as excess nominall; GDP growth. Also aSsume that inﬂationary rezxpectz‘itions,pe ‘
.adjustaccordingto the following/rule;  W ‘ ‘ ' . ' ' ' L Supply shOcks have been absent in the last years and government has maintained a
constant rate nominal GDP. growth of 1%»(i.e. yz=0randx=1 in all years up to and , ~ ‘ including 1999). ‘ The economy is in the steady state in 1999. V __ v I a‘) (2 points) Write the equations for andSP curve and sclve for the initial and V
_‘p‘in’1999. ‘ r V / or. " ‘  , _ (4 points) Suppose that in the year 2000, an uneXpected military‘conflict in Asia 2
' causes a rise in government expendituresincreasing x to 3%. Find the year 2000 levels _
of I; and p, ' I L ' ‘ ' ‘ ‘ ' ' ' I ~: ‘0) (14 points) Suppose, that,y,due topreSidential'elections in the year 2002, the ‘ _ government as anobjeetive toiimpleinent Yto be V0 in theyea’r 21002; (i.e. j   electors value stability); In order to 'iachi’evethisobjective, the goyermnent‘hasto f _ _ ‘  announce a‘constantgleVel‘ of forthe years 2002 The govemmentexpects no
‘. shocks during thesej'Z the level of be Chosen? ”  . ‘ 1_QUEsTION3(14points)T ‘ I L‘ Consider an economy Withrpositive laboraugmentingtechnological progress. I The production function for the economyis given by: , , r I g _ '_ ‘ '_ LYV=’F(K, XN), ,, L, whereX grows at a, rate x>0vand N grows‘at rate 114:0. (ﬂiere'isno_p0pulation, grOwth), and F is aconstant realms to scale production'functi‘on. g r _ ; y
The economy is initially in steady state, where the; values of the capital stock and
effective labor are K0 and XoNo, respectively. The savings rate 5 isconstant, and the r ‘ ‘ ' , depreciation rate is equal to zero. _ ' _ ' a), (3 points) What is the steady state condition that No, and X0 must satisfy? L, _ _
(Hint: «What is steady State investment demand? What are savings per unit of effective ‘ , labor?'To gain intuition, you may use the graph [belowijNote that a, graphical answer is ‘ ,not sufﬁcient.) ’ '  , yS,Inv Kim/(mo), ' , K/(XN) ’ I b) (Zipoihts) is the grow rate of caipi‘ta output the‘steady state? I I I ' I ’ Now suppose there is a" biletithe increase‘i‘n the number of workers dueto °
'_ immigration'(N goes up, and stays at the new level‘a‘ﬂerwards). ‘_ ,r f5 ’e) (i) (2 points)"At the timethe increase doesotitputpet of effective labor I
1risesfallotstaythesame?.Why‘z.’ 4 == “ 1 s , ‘ w *  _ ' ' (ii) :(2 points) Is; there any further change inbuitput per unit (ifeffective labor after the ' change (if any) in output per unit of effective labor at the time the newworkers appear? If V ‘ t  I , so, does output per unit of effective labor rise or fall? Why? I,  ’ aid) poin‘tS) the steady‘state edrreSﬁendinfgy t6 the'iiew leVel of N, is output pet unit of _V 7 ‘
, _’ effective labor higher,"lower er'the same as it Was before the increasein, N? Why? ‘ .(ﬂr’ 1 e) paints) the Steady state coneSpbndiiigte the new level of N,‘ is; per ,capita output L 1
‘ 1 higher, lower or the same as. it Was beforethe increase (Assume that the ‘ ‘ " ‘ adjustment processtoek sonic time);  r  ‘L I investment on average over the period ,1 918571995?! YOUR Essay 1’ (18 points). 'Using'deﬁnitiens @d’ihadéls developed in the may; * _ _ .a. Explainithe relationship rough orders of magnitude among the government 4, ' budget deﬁeit,’foreign investment or borroWing, domestic saving,’ and domestic} ' ; Vb. ’Howkdiidthei'elatienshi,yibetuieen thesemgmmdestchange between 1995 and; , a " I
' 1998? «What were the causes ofthesechangesfgg,4, ‘ ' » a '  \4  Essay‘z (18 points). In its ﬁrst year (up until last Friday) the mummiﬁed from; I 1
' $1,17‘to $1 .‘01 and the Japanese yen had appreciated from 120 to theU. S, dollar to 102. _ at Using any‘approachate explaining excehange rates that you learned in the eourse,
explain these exchange ratemovements._ ; a, '  ' " r k ‘ ' ' ' ‘ b. the implicatiens of mouemmt fer Japanese economic policy? ‘ ...
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 Spring '08
 GORDON

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