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business
behavioral economics

Questions and Answers of Behavioral Economics

Distinguish between Keynesian unemployment caused by an aggregate demand deficiency and classical unemployment due to real wages being above the full-employment level. What can monetary policy do to
Keynes argued that an economy could be in equilibrium with a substantial amount of involuntary unemployment, but other economists took the stand that an equilibrium in which an important market does
“The classical theory dominates the economic thought, both practical and theoretical, of the governing and academic classes of this generation, as it has for a hundred years past.…[But it is]
Start with the neoclassical model and assume that its equilibrium solution is (yf , nf , r∗, P∗). Suppose a reduction in investment reduces aggregate demand. Discuss the following:(a) Within the
Suppose the central bank pegs the price level by using money supply changes through open market operations. Present the IS–LM analysis incorporating this money supply rule and show the implications
“From the time of Say and Ricardo the classical economists have taught us that the supply creates its own demand … (and) that an individual act of abstaining from consumption necessarily leads
Suppose that business pessimism reduces investment such that aggregate demand becomes less than full employment income at all non-negative rates of interest. Use IS–LM analysis to answer the
You are given the following fixed-price, closed-economy, IS–LM model:IS: y = c[(1−t1)(y+b/r),M +b/r]+i(r, y)+g LM: M = md(R, y,M +b/r)Fisher equation: with an exogenously specified expected
(a) Describe a simple fixed-price short-run macroeconomic model (with flexible nominal wages) and compare it with a conventional market-clearing model.Compare their predictions for the effectiveness
Discuss in the context of the neo- and new Keynesian models: excluding dynamic effects, an increase in the stock of money and a fall in nominal wages have essentially the same effects at a time of
Discuss in the context of the effective demand and Phillips curve Keynesian models:excluding dynamic effects, an increase in the stock of money and a fall in nominal wages have essentially the same
“In response to demand shocks, short-term quantity adjustments occur earlier than price adjustment at the level of both the firm and the economy.” Discuss the relevant theory behind this
If the central bank cannot change output and unemployment through systematic money supply changes and its induced changes in the anticipated inflation rate, should it try to do so by changes in the
How do (i) real business cycle theory, (ii) Friedman–Lucas supply analysis, explain fluctuations in unemployment over the business cycle? What is the impact on unemployment of changes in aggregate
What is the empirical assessment by Lucas of the importance of short-run fluctuations in unemployment and output due to errors in expectations? Discuss other possible reasons for such fluctuations.
Discuss the empirical validity of the implications of the modern classical model for(i) the long run, (ii) the short run.
What are main tenets of the modern classical school and how do they differ from those of the traditional classical school?Discuss critically the contributions of the modern classical school to our
The 1970s monetarism and the new classical school are sometimes lumped under the same banner. How do these schools view the existence of short-run unemployment in the economy and what policies does
The “crowding out” hypothesis asserts that investment is crowded out by fiscal deficits.Is it fully or partially valid in (i) the IS–LM model, (ii) the neoclassical model, or (iii) the long-run
“In response to demand shocks, short-term price adjustments by markets occur earlier than quantity adjustments at the level of both the firm and the economy.” Discuss the relevant theory behind
“The rate of money growth is the sole determinant of aggregate demand and the trend rate of inflation, and the stance of fiscal policy is irrelevant.” Discuss.
Discuss the proposition that a change in the rate of growth of the money supply will not affect output and unemployment in the short run, as well as in the long run, if wages and prices are fully
Present the new classical model (with rational expectations and Ricardian equivalence).Analyze the role of monetary policy in this model.Howwould this model explain the major recession in the early
Specify a model that generates real business cycles only. Discuss whether this model allows for the observed cyclical correlation between money and output.
Discuss whether the existence of business cycles and the observed positive correlation between real and monetary variables mean that the modern classical models are neither valid nor relevant for
“In a closed economy, if the money stock is held constant by the central bank, an increase in the government deficit does not have either short-run or long-run effects on aggregate demand and
“For the economy to have a determinate price level and money to have a positive value, it is necessary that the economy have a demand for money and a mechanism for limiting its supply.” Discuss
One of the banking innovations in the 1960s was the payment of interest on certain types of demand deposits. Assume that interest is paid on money at the nominal rate Rm, which equals (R−x), where
The monetary authority has decided to adopt one of the following money supply rules:(a) Ms = kPy(b) Ms = ky where k > 0.Show their implications for aggregate demand, prices and output in the context
Present the analysis of the statement that the effects of government deficits on the rate of inflation and real output and unemployment depend on the way in which the deficit is financed.Also,
Suppose that the government wants to increase its expenditure g and has the options of financing it by higher taxes, bond issues or increases in the monetary base. Further, when g is increased
Discuss the analytical and empirical validity of the statement that the Pigou effect ensures that full-employment equilibrium exists if prices and wages are flexible.
“In the context of the modern classical model, the rate of money growth is the sole determinant of the trend rate of inflation, and the stance of fiscal policy is irrelevant to it.” Discuss.
In the preceding question, suppose the central bank uses open market operations to aim at the money supply. Discuss the case for it to allow borrowing from it by commercial banks at the latter’s
Assume that the IS and money demand equations each have a disturbance term. Further, assume that the central bank can control the economy’s interest rate r and money supply Ms except for
What would this imply for the validity of the Ricardian equivalence theorem?Formulate and specify at least one other estimation equation for testing the Ricardian equivalence theorem.
An empirical study tested for the Ricardian equivalence theorem by estimating the following equation:At = a0 +a1Bt +μt where A is the public’s net real financial assets (excluding its holdings
Discuss the rationale and validity of the following statements: “It makes no difference whether government expenditures are financed by money or bonds.” “A fiscal deficit has a larger impact on
“It makes no difference whether government expenditures are financed by taxes or bonds.” Specify a theoretical basis for this statement. Provide at least two reasons why it may not hold.
In the IS–LM model, discuss how each of the following affect the relative efficacy of monetary and fiscal policies:(a) the interest elasticity of money demand;(b) the interest elasticity of
What are the ways or reasons under which fiscal deficits can crowd out private expenditures in the determination of aggregate demand? In this discussion, do not forget the Ricardian equivalence
The “crowding out” hypothesis is the statement that fiscal deficits reduce investment; in the limit, full crowding out means a reduction in investment equal to the fiscal deficit.Is crowding out
Can monetary and fiscal policies be independent of each other? If not, why is their independence postulated in the IS–LM and IS–IRT analyses? Discuss.
Assuming that the central bank follows a simple interest rate target rule, write an essay on the determination of the money supply that would maintain equilibrium in the money and bond markets.
Assuming that the central bank follows a simple interest rate target rule, modify the general IS–IRT model of this chapter to the appropriate one for a closed economy.Specify its IS and aggregate
Modify the general IS–LM model of this chapter to the appropriate model for a closed economy. Specify the IS, LM and aggregate demand equations. What causes the dependence of aggregate demand on
“In a closed economy, if the money stock is held constant by the central bank, an increase in the government deficit does not have either short-run or long-run effects on aggregate demand or the
One of the banking innovations in the 1960s was the payment of interest on certain types of demand deposits. Assume that interest is paid on money at the rate Rm, which equals(R-x), where x is
The central bank has decided to adopt one of the following money supply rules:(a) Ms = kPy(b) Ms = ky where k > 0.Show their implications for aggregate demand in the context of (i) the IS–LM model
Present the analysis of the statement that the effects of government deficits on aggregate demand depend on the way in which the deficit is financed.Also, analyze the above statement for the
Suppose that the government wants to increase its expenditure g and has the options of financing it by higher taxes, bond issues or increases in the monetary base. Further, when g is increased
It is often asserted that there is a national income identity, so that in a closed economy without a government sector there is an identity between saving and investment. Explore the implications of
For a small open economy with a floating exchange rate whose movements continuously ensure equilibrium in the balance of payments, draw the locus of points in the IS–LM diagram (with the interest
What advice would you give the central bank of your country on the appropriate monetary policy to follow at the present time? Your answer must specify your assessment of the current state of the
Suppose that the economy is such that a positive monetary shock reduces unemployment.Assume that the central bank likes a reduction in unemployment but dislikes an increase in inflation. The public
Given the utility function in the preceding question, assume that the economy has an expectations-augmented Phillips curve such that:u−un =−0.1(π −πe)Derive the optimal values of u and π for
Assume that the central bank has the utility function:U =−u2 −0.5π2 where U is utility, u is unemployment and π is the inflation rate. Assume that the economy imposes a constraint in the form
Present the IS–LM analysis for the case of negative shifts in the vertical aggregate supply curve when the targets are (i) aggregate demand, (ii) price stability, (iii) output. Compare the output
“Each time the central bank changes its discount rate, there always seems to be plenty of criticism from many economists, some claiming that the change is not needed or too much while others claim
“For pre-specified goals, it is easy for the academic economist to prescribe the course of monetary policy for the period ahead. But the devil is in the details: the limitations on the knowledge of
“The time consistency literature suggests that it is always a good thing to have a tough central banker who cares about inflation and not at all about unemployment – even if society cares mainly
What is the relationship between rational expectations and the credibility of monetary policy? What do they imply for the relevance of credibility to the success of an antiinflation program? What do
Show that there can be an inflationary bias in discretionary myopic policies.
The time consistency of policy requires the specification of a policy plan for the future, say for the next five years, and the determination to stick to it. Under what conditions –and shocks –
It is often argued that independence of the central bank from the government and the legislature would lead to a lower inflation rate. Why, and under what circumstances is this likely to happen?
Who should determine the economic policy goals for the nation: the government democratically elected by the public or a central bank whose directors (or governors)are not elected and cannot be made
“The standard practice of governments whereby they define the monetary unit is unnecessary and undesirable. The private sector should be encouraged to choose its own standards in a free competitive
“Due to fairly radical changes in the structure of the financial sector in recent decades, the importance of demand deposits has declined considerably and the role of commercial banks has changed
Suppose that instead of imposing reserve requirements on demand deposits in the commercial banks, the central bank does the following: require automobile owners to hold $500 of non-interest-bearing
What does financial intermediation mean? What are the different financial intermediaries in your country. Which of their liabilities would you classify as components of the monetary aggregates?
Suppose that for a given economy the preconditions for the effective pursuit of open market conditions are not met. What monetary policy tools are likely to be the most effective ones for such an
The pursuit of selective fiscal policies in the form of tax exemptions and subsidies is common in almost all countries, whereas the usage of monetary policy on a selective basis is rare in the
How can central bank discounting cause procyclical movements in the money supply?How can the central bank eliminate such a movement? Discuss.
Why has the use of changes in reserve requirements as a tool of monetary policy been largely abandoned in Western economies? What were the reasons for the virtual elimination of reserve requirements?
What are the tools available to the central bank for controlling the money supply? Discuss how manipulation of each of these tools will change the money supply and how reliable each tool is likely to
Should the United States and Canada follow the example of Britain in giving the government the power to set the ultimate goal or goals of monetary policy, while leaving the implementation of these to
What is the lender-of-last-resort function of the central bank in modern economies?What is its justification? Should commercial bank borrowing from the central bank be a privilege or a right? Discuss.
Can central banks pursue and achieve multiple goals or must they be confined solely to fighting inflation? What goals are embedded in the Taylor rule? Discuss.
Historically, what goals were mandated for central banks? Why have the goals pursued in recent years been narrowed to “inflation targeting”?
Are there, in general, any problems with the application of cointegration techniques to money supply functions, or with the interpretation of estimates? Can these estimates be relied upon? Discuss.
What are the reasons for requiring the use of cointegration techniques in estimating the money supply? What would be the disadvantages of using ordinary least squares for such estimation? If you use
For a selected country and using quarterly data, specify and estimate the money supply function. Among your independent variables, include at least two different interest rates, one being the
How would you formulate your money supply function for estimation in an empirical study? What would be your definition of the money supply variable? What would be the arguments of your function?
Specify a money supply function in terms of the currency and reserve ratios and the monetary base. Let the real money demand function be:md = md(y,R) = myy −mRR+FW0 ∂md/∂y > 0,∂md/∂R <
Given the information in the preceding question,(i) If k = 0.05, ER = 0.01D, c = 0.2, C +D = 0.03 y, derive M0 as a function of y.Also, derive C, D and BR as functions of y.(ii) Suppose financial
Let BR (bank reserves) be:BR = kD+ER Assume:ER = f (R,Rd)D ∂ER/∂R < 0,∂ER/∂Rd > 0 where ER is excess reserves, R is the market interest rate, Rd is the central bank’s discount rate and the
Specify the behavioral money supply function that captures the behavior of the central bank, the public and the banks in the money supply process. Discuss and compare its likely interest-rate
Discuss what will happen to the monetary base and the money supply if the central bank starts paying interest, say at the Treasury bill rate, on commercial bank deposits with it. If it does so, would
Would a high (in the limit, 100 percent) reserve requirement imposed on banks strengthen central bank control over the money supply? If so, why do central banks never impose very high reserve
Does the central bank have tight control over the money supply? What are the factors that weaken the link between the central bank policies and changes in the money supply?
Show what happens to the money supply if:(a) the economy enters a boom and interest rates rise;(b) the underground economy with illegal holdings of currency is eliminated;(c) firms give a significant
What happens to the monetary base and the money supply if:(a) the central bank lowers the discount rate;(b) the central bank lowers the discount rate and also sells bonds to the public;(c) the
What happens to the monetary base and the money supply if the government finances a fiscal deficit by:(a) selling bonds to the public;(b) selling bonds to the commercial banks;(c) selling bonds to
“Macroeconomic models assume that the money supply is exogenously specified by the central bank. If this is so, there is no purpose to the specification and estimation of money supply functions.”
Note that recessions seem to be caused by either reductions in aggregate demand or in aggregate supply, or by the two acting in concert. What targets should the central bank adopt? Would the optimal
The monetary sector has become increasingly unstable in recent years. Does this mean that the monetary authority should stay with the pursuit of interest-rate targets and leave the money supply alone?
How do central banks manage interest rates in your country and one other country of your choice? What consequences for output fluctuations can the central bank expect from targeting interest rates?
Discuss, using diagrams, the following statement: if the money demand function has a high interest inelasticity, the case for a monetary aggregate as against an interest rate as the central bank’s
Design a study to judge whether a central bank of a country uses the interest rate or the money supply as its operating target of monetary policy. What relationships and tests can you use for this
Conduct an empirical study along the lines suggested in the preceding question for a country of your choice, and discuss your findings for the effectiveness of monetary policy pursued through

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