Problem #1 .
Consider an economy with the demand side characterized by the following set of equations yt = ?t - ?(rt - p) + ?t rt = it - ?t it = ?t + p + ?? (?t - ?*) + ?y(yt - ?t) i) Derive the equation describing the DAD curve in this economy Now, assume that the Phillips curve the economy can be described with ?t = ?te + ?(yt - ?t) + vt, where ?te denotes expected - from the perspective of period t 1, inflation at time t. Furthermore, assume that expectations are formed according to ?te = ??t-1 + (1 - ?)?t ii) Derive the equation describing the DAS curve in this economy. Let the parameters assume that following values: ?t = 0, ? = 0.5, p = 0.03, ??= 0.25 , ?y = 0.75 , ?*= 0.02, and ? = 0.5 . Finally, for now assume that ? = 1. iii) Find the long run equilibrium in this economy iv) Assume that the economy has been in he long run equilibrium for some time. Use your favorite software to simulate what happens to the key economic variables if the economy experiences a temporary shock to demand. Specifically, assume that at time t we have ?t = 0, and then ?t+1 = 0.01, ?t+2 = 0.01, ?t+3 = 0.01, ?t+4 = 0.01, and then ?t+i = 0 for i ? 5. For each period, starting at period t through period t + 9, find the absolute value of the deviation of the actual output from the potential then calculate the average of the deviation. v) Redo the above exercise assuming that now ??= 0.75 and ?y=0.25 . Is the average of the deviation higher than before? vi) Now, assume again that ??= 0.25 and ?y=0.75. Redo the above exercise for the following values of ? ? {0.75, 0.5, 0.25}. For which value of is the average deviation the smallest?.
Problem 2.
16. An inverted yield curve: a. Slopes up b. Is flat c. Slopes down d. Has a U shape e. Has an inverted U shape
17. According to the expectations theory of the term structure, a. The interest rate on long-term bonds will equal an average of short-term interest rates that people expect to occur over the life of the long-term bonds b. Buyers of bonds do not prefer bonds of one maturity over another c. Interest rates on bonds of different maturities move together over time d. All of the above e. Only (a) and (b)
18. According to the expectations theory of the term structure, a. The interest rate on long-term bonds will equal an average of short-term interest rates that people expect to occur over the life of the long-term bonds b. Interest rates on bonds of different maturities move together over time c. Buyers of bonds prefer short-term to long-term bonds d. All of the above e. Only (a) and (b)
19. According to the expectations theory of the term structure, a. When the yield curve is steeply upward sloping, short-term interest rates are expected to rise in the future b. When the yield curve is downward sloping, short-term interest rates are expected to decline in the future c. Buyers of bonds do not prefer bonds of one maturity over another d. All of the above e. Only (a) and (b)
20. According to the expectations theory of the term structure, a. When the yield curve is steeply upward sloping, short-term interest rates are expected to rise in the future b. When the yield curve is downward sloping, short-term interest rates are expected to decline in the future c. Investors have strong preferences for short-term relative to long-term bonds, explaining why yield curves typically slope upward d. All of the above e. Only (a) and (b)
Problem 3.
9:34 PM Fri Sep 20 00:00 5 AmBank Group chief economist Anthony Dass, who is maintaining the 3% OPR stance, added that following the 25-bos cut in May, the impact on the economy has been positive with improved lending data. Hence, there is no real urgency for another rate cut in the form of a back- to-back action, he noted. It is likely that Bank Negara would remain vigilant with its monetary policy with the aim to support growth, and at the same time, ensure price as well as currency stability. Besides, ongoing global uncertainties still remain, Dass said. "Room for a potential rate cut in the remaining months of 2019 is still on my plate. The possibility of another 25-bps cut could happen should the potential underlying macro figures take a dip such as inflation, growth and lending. "Also, if the global downside risks flare up with increasing monetary easing taking place, it further opens the door to a rate cut to take place to ensure interest rate differentials do not widen too much and put us in an awkward position. At this point, the probability of another rate cut happening in the fourth quarter is about only 40%," he said. Dass said that inflation is expected to stay tame in 2019, at around 1%. There is limited pressure coming from the underlying inflation, telling us that demand-driven inflation is still tame, he said. Any upward spike to inflation, according to Dass, is more likely to be fueled by cost-driven factors. Maybank Investment Bank group chief economist Suhaimi Ilias said: "We do not expect any change at today's MPC following the preemptive 25bps cut in May 2019 amid re-escalation in US-China trade tension and signs of US Fed ending rate hike and starting rate cuts. We do not rule out further OPR cut, but pending outcome of latest trade truce between US and China. Failure to reach an accord will intensify risk of full blown US-China trade war and adverse impact on external demand that would necessitate policy action by the central bank to support domestic growth." Source: Daljit Dhesi (July 9. 2019). The Star Online. Answer the following questions based on the article. Examine the objective of overnight policy rate (OPR) and how it works. (4 marks) 2. Which type of government policies that you learned in Topic 9 (refer to teaching plan) or Chapter 14 (refer to text book) that this OPR can be classified? (2 marks) 3. Illustrate graphically with a short explanation on how will the OPR reduction affects the property sector, inflation rate and gross domestic product (GDP). (12 marks) 4. Analyse in general what will happen to the Malaysia's bond market (interest-bearing asset) and value of ringgit (RM) when OPR reduced to 3%. (6 marks) According to AmBank Group chief economist. Anthony Dass, demand-driven inflation is still tame and any upward spike to inflation is more likely to be fueled by cost-driven factors. Evaluate his statement. (6 marks)9:34 PM Fri Sep 20 INSTRUCTIONS: 1. Students are required to answer all questions individually. 2. Your answers should be typewritten with Times New Roman 12' font, 1.5 spacing and ought to be submitted during lecture class in week 13, 23 September 2019 for grading. 3. Late submission is not acceptable. If it happens that you are not well on that day and time. please email me your assignment at this address: norhazlin.ismail@ mmu.edu.my before 5pm on that day. 4. If you submit a plagiarist work, you shall be given zero for your assignment. Read the following article: "Bank Negara set to retain key interest rate" PETALING JAYA: Bank Negara is expected to maintain the benchmark interest rate at 3.00% at its Monetary Policy Committee (MPC) meeting today although there is mounting pressure for a further rate cut later this year. According to economists, the central bank would maintain the existing key benchmark rate for now, but would need to assess the macroeconomic conditions and uncertainties and how it would impact the local economy. In its last MPC meeting in May, the central bank decided to reduce the overnight policy rate (OPR) to 3.00% from 3.25%. The OPR was last cut in July 2016 to 3.00%, following the Brexit vote in the UK. Twenty-one of 24 economists surveyed by Bloomberg expect Bank Negara to keep the benchmark rate unchanged today, while three have forecast a 25-basis-point (bps) cut. Bank Islam Malaysia Bhd chief economist Mohd Afzanizam Abdul Rashid told StarBiz that "I think the decision by the central bank on the OPR would be very much in line with median estimates, whereby it would be maintained at 3%. "What is more important is the bank's assessment of the state of the Malaysian cconomy in the second half of this year, especially since the global Purchasing Managers' Index for the manufacturing sector has been below 50 points for two consecutive months amidst the backdrop of heightened uncertainties on the trade war, Brexit and crude oil prices. "We believe the window to deliver another round of OPR cut is widely open, as the inflation rate is expected to be below 1% this year. Apart from that, the economy is currently operating below potential, and therefore, any economic stimulus from the authorities, be it monetary or fiscal, is highly welcome. "Our sense is that the central bank would want to cut the rates further, but the upcoming FTSE Russell review in September could pose a challenge to the ringgit. So, for now, it's status quo," he said. Recall that In April, FTSE Russell said it would review the nation's government bonds' participation in the World Government Bond Index (WGBI) due to market liquidity issues. It has placed Malaysia on its fixed-income watch list for six months until September
