c11ffall99sol

c11ffall99sol - PART A (40 points) Write your answers to

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Unformatted text preview: PART A (40 points) Write your answers to the’multiple—choice questions in the space below. WRITE LEGLY! 1.___B____ 11.____B______ 21 ____C____ 31. D_______ 2 ____C_ 12 _C_____ 22 ___A____ 32 __B_ 3. ____D___ 13’._B_____ ‘23.___C____ 33. C__ 4. __C___ 14. __A____ 24. ___C______ 34. ___B______ 5 ___B_____ 15 _B_____ 25 _C__ 35 __C__ 6 _D___ 16. ____A___ 26. ___B__ 36. E____ 7 ____C_ 17. ___A___ 27 _B___ 37. ___C__ 8 _ __ 18. ;_A_ 28.___E___ 38. __A_______ 9 B 19 E 29 C 39 C l I | I I l l S U N O U U) 0 O I; .0 I it? I I I PART B QUESTION 1 The just elected president of Uruguay hires you to advice him on which exchange rate system to adopt. Uruguay is a small open economy, which takes the interestrate as given from the international capital markets; A (a) In order to reduce the volatility of the exchange rate, the new government is thinking of adopting a-fixed eXchange rate syStem. This decrease in uncertainty could potentially enhance the confidence of foreign investors when deciding to invest in Uruguay. As an expert in the small open economy lS—LM model, you know that a drawback of a fixed exchange rate is that the government loses'control on one of its policy variables (either G, T orMS) to affect the output level (Y). Y Which is the policy variable that has no-effects on Y under a fixed exchange rate system? (Hint: Either monetary or fiscal policy). MONETARY POLICY Explain how you reached this conclusion in Panel A (next page), showing the movement in the IS and LM curves and the resulting equilibrium from this policy. (Note: in panels A and B, rf is the international interest rate and E0 denotes the initial : equilibrium). M (b) The president also explains that he plans to reduce the budget deficit in the next years V by reducing the number of public employees. However, he wants to avoid causing a recession as a result of this contractionary fiscal policy move. Again, using the small open economy IS—LM model, you know that one of the exchange rate regimes you studied in C11 can avoid a recession after a fall in G. ' Which exchange rate system delivers the ineffectiveness of fiscal policy on output? FLEXIBLE EXCHANGE RATE Explain how you reached this conclusion in Panel B, showing the movement in the IS and curves and the resulting equilibrium from this policy. ‘ ' Would the exchange rate after the decrease in G' have appreciated or depreciated compared to the initial equilibrium? ‘ DEPRECIATED PANEL A: LMO=LM2 LM1 Real Y GDP 1) money supply increases; 2) LM shifts out (LM2); 3) interest rate falls; 4) outflow of V capital; 5) M falls; 6) LM shifts back; 7) back to initial equilibrium, with lower reserves. PANEL B: ‘ R ‘ LM ISO=ISZ Real Y GDP 1) G falls; 2) IS curve shifts in (ISI); 3) interest rate falls; 4) outflow of capital; 5) exchange rate depreciates; 5) net exports increase; 6) IS shifts back; 7) back to initial equilibrium, with a depreciated exchange rate. QUESTION 2 Consider an economy with the follOwing SP relationship p=pe+0.5 19 +2 where p and p6 are actual and expected rates of inflation, l? is the log output ratio (where Y =100*ln[Y/YN] where YN is the natural rate of real output) and z is a supply shock. Assume that the natural rate of real output growth is zero, so that nominal GDP growth is the same as excess nominal GDP growth. Also asSUme that inflationary expectations pe adjust according to the following rule: ' ' PEP-1- Supply shocks have been absent in the last years and the government has maintained a constant rate nominal GDP growth of 1% (i.e. 2:0 and x=1 in all years up to and including 1999). The economy is in the steady statein 1999. a) Write the equations for the DG and SP curve and solve for the initial Y and p in 1999. SP: p=1+0.5 )9 +0 DG: p=1-Y+l;-1 19:19.1 = 0 pezp-1:x:1 b) Suppose that in the year 2000, an unexpected military conflict in Asia causes a rise in government expenditures, increasing x to 3%. Find the year 2000 levels of l; and p. x23; p-1=1; f4 = 0 SP: p=1+l9 DG: p=3- )9 Equilibrium: 1+? = 3 )9. So, i? = 2 and p= 1 . Aiwmtz..ww-rrw.w. , ., u ,, m A 0) Suppose that, due to presidential elections in the year 2002, the government has as an objective to implement l; to be equal to 0 in the year 2002. (i.e. electors value stability). In order to achieve this objective, the government has to announce a constant level of x for the years 2001 and 2002. The government expects no shocks during these 2 years. What is the level of x that should be chosen? Start of 2001: Y‘_1=2 and p.1=1. Given x: SP: p: 1 + ll} DG: p=x-l?+2 So,1+ l7”: x—f-I—Z, or sz/Z +1 /f‘2 ; and p :2 x/2 +1.5 Start of 2002: 17' _1= x/2 +1/2 and p_1= x/2 +1.5 Given x: A SP: p: x/2 +1.5 + Y DG: p=x- )9 + x/2 + 1/2 We want l?=0. So, p = x/2 +1.5 and p: 1.5 x + 0.5 So, x=1 and p = 2. QUESTION 3 Consider an economy with positive labor—augmenting technological progress. The production function for the economy is given by: Y=F(K, XN), where X grows at a rate x>0 and N grows at rate n=0 (there is no population growth) and F is a constant returns to scale production function. 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 3 is constant, and the depreciation rate is equal to zero. a) What is the steady state condition that K0, N0 and Xomust satisfy? Solution 1: Analytical Scale the production function by NX. . The capital accumulation equation here is = sY 2 SF (K , XN) For the capital per unit of effective labor, we have dKA__dAK dX i I. __1_ M __1_ M-_Zt_£ _Sf .15. _x_1_<. dt XN' N A2 .N‘ X X X XN XN In the steady state fl— —K— 20,80 sf £— _ 2 xi. dt- XN XN XN Solution 2: By Analogy ’ - We know that in the model with disembodied technological change (i.e. Y=XF(K, N) ), and nonzero population growth rate It the steady state relationship is given by K ,_ Ii; sf(7V—]—nN Note that in our case we have Y=F(K,XN) and the effective labor (that is, XN) grows at a rate x, since the population is constant (self-check question: what would be the growth rate were it not constant ?). After scaling by effective labor, we have exactiy the same functional form as we had in - the model in class, just x takes place of n, and the place of N. So the steady state relationship is K r K L Sf[ XN) x XN . ( ) Yo/(XoNo) Y1/(XoN1) b) What is thergrowth rate of per capita output in the steady state? As we see that the steady state level of capital per unit of effective labor is given by (1), that is, it is constant. Therefore, Y/(XN) = f(K/XN) is also constant. Then, per capita output Y/N = X*(_Y/(XN))=X*Const, which grows at exactly the rate x. Now suppose there is a one-time increase in the number of workers due to immigration '(N goes up, and stays at the new level afterwards). c) (i) At the time the increase occurs, does output per unit of effective labor rise, fall or. stay the same? Why? When N1>N0, K0/(X0No))> Ko/(XoNl) (that is, the capital does not jump) and f(Ko/(X0No))> f(Ko/(X0N1)) because f is an increasing function, so , Y0/(X0N0) > Y1/(X0N1), and the output per unit of effective labor falls (see picture below) (ii) Is there any further change in output per unit of effective labor after the change (if any) in output per unit of effective labor at the time the new workers appear? If so, does output per unit of effective labor rise or fall? Why? * .x K/(XN) f(K/(XN)) s f(K/(XN)) Ko/(XoNo) Ko/(XoN 1) K/(XN) After the jump, the savings will be at point B in the graph above. Since none of the rates change, none of the lines shift. That’s above the xK/(XN) line, so net change in capital per unit of effective labor will be positive. It Will increase until we are again at the point A, that'is, at the old steady state. d) In the steady state corresponding to the new level of N, is output per unit of effective labor higher, lower or the same as it was before the increase in N? Why? Since we are again in the old steady state, output per unit of effective labor is exactly the same as it was before. ' e) In the steady state corresponding to the new level of N, is per capita output higher, lower or the same as it was before the increase in N? (AsSume that the adjustment process took some time). ' Since we are in the old steady state again, we know that the output per unit of effective labor is exactly the same as it was before, that is, ' Y1 _ Yo, X1N1‘.X0No It is easy to see that ‘ ULJELE’L ,Nl X0 0 Since x is positive, and the adjustment process took time, X will have grown by some ' amount during that time, so thatX1>X0, or X1/X0>1, and therefore, Y1/N1>Y0/No, that is, per capita output after the adjustment Will be higher than before. ...
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This note was uploaded on 09/04/2010 for the course ECON 311 taught by Professor Gordon during the Spring '08 term at Northwestern.

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c11ffall99sol - PART A (40 points) Write your answers to

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