Work out the following
Multiple Choice (30 points) 1. (30 points) Mark box if true - each multiple choice question has only one right answer. (a) (2 points) If P, is the price level in time t, then inflation is calculated as: O 1/PI O PH+1/ Pi O PH+1 - P O P/ PH+1 O (PHI - P.)/ P (b) (2 points) In the United States, money is backed by: O oil O gold O silver O no physical commodity O None of these answers are correct. (c) (2 points) According to the quantity theory of money, the price level is: O Exogenous O Determined by the money supply only O Determined by the ratio of the effective quantity of money to the volume of goods O Indeterminate in the long run O Determined by the volume of goods produced (d) (2 points) Net worth is equal to a bank's O investments minus deposits O cash plus reserves O deposits plus loans O loans minus capital O total assets minus total liabilities (e) (2 points) Using the IS curve Y = a -b(R - F), in the long run, a . and , so that O equals one; Re = 7; the economy is in recession O is greater than one; R: > 7; the economy is at its long-run equilibrium O equals zero; Re = F; the economy is at its long-run equilibrium O equals one; b = a; the economy is expanding O equals one; R: = 1; the economy is in recession. (f) (2 points) Consider the consumption function Ct/Y = a, + ZY. If # = 0.5, a 2 percent demand shock:Exercice 1 (15 points) 2. (15 points) Consider the following balance sheets for three hypothetical financial insti tutions, bank A, bank B and bank C. Bank A's Balance Sheet Assets Liabilities Cash 600 Deposits 1400 Loan to bank B 500 Mortgage-Backed Securities 400 Total assets Total Liabilities Equity (net worth) Bank B's Balance Sheet Assets Liabilities Cash 1000 Deposits 900 Loan to bank C 500 Loan from Bank A 500 Total assets Total Liabilities Equity (net worth) Bank C's Balance Sheet Mortgage-Backed Securities 800 Deposits 200 Loan from Bank B 500 Total assets Total liabilities Equity (net worth) (a) (2.5 points) Fill in the missing entries in the balance sheets (denoted (b) (2.5 points) What is the leverage ratio in each bank? (c) (10 points) Suppose housing prices fall sharply and the mortgage-backed securities as a consequence fall in value by 50%. Assume that banks first make good on their deposits, before actually repaying other banks. Calculate bank A's new net worth. (be careful, two banks hold Mortgage-Backed Securities !)Exercice 3 (50 points) 4. (50 points) Take the usual AS/AD model, ruling out Aggregate Demand shocks, so with a = 0, but assuming a one-time, unexpected oil price shock of > 0. One time means that the oil price shock lasts only for one period, in period t = 0, and that &, = 0 for all subsequent & E {1,2, ...}. Unexpected means that the economy was originally in steady-state, and in particular that No = #. Unless otherwise noted, agents have adaptive expectations about inflation. The economy is described by an AS/AD model. In particular, the AS curve is given by (be careful about the convention on the timing of the oil shock of-1 !): It = If+ DY + 01-1. The AD curve is the standard one used throughout the course. (a) (5 points) What are the values of m and Y in terms of the parameters of the model? (in particular the size of the oil price shock, op) (b) (5 points) Show analytically' the effect of a more agressive monetary policy on in- flation and short-run output in period 1: do inflation and short-run output increase or decrease with a more agressive monetary policy? 'That is, in mathematical terms. Macroeconomic Theory 102 Midterm 2 - Page 8 of 11 Wednesday, February 25, 2015 (c) (5 points) Illustrate this on two graphs with the AS/AD curves: show one AS/AD diagram with a soft monetary policy, and next to it another AS/AD diagram with an agressive monetary policy. Show m and Y, as well as the long run values of inflation and short-run output on these graphs. (d) (5 points) Eliminating Y, from the AS/AD model, find a difference equation for rtel2 3..(k) (2 points) The Fisher equation is given by: Out - 1 = -(1/2) Y O P: = MP O An = DY + 5 Ou = Re - Tit. Out = Re + It. (1) (2 points) When the central bank announces expansionary monetary policy and all other economic agents build this into their decision making, as a consequence with no economic benefit; this is called the problem. O output rises; policy lag unemployment rises; time inconsistency expectations rise; adaptive expectations inflation rises; time inconsistency O inflation rises; discretionary (m) (2 points) In the presence of rational expectations, the central banks' willingness to battle inflation: O causes future inflation becomes a determinant of past inflation undermines the ability to fight inflation becomes a determinant of expected inflation )weakens the central government. (n) (2 points) If the government gives firms a temporary investment tax credit: O firms will invest now rather than in the future O it will increase a; O it will increase a O) All of these answers are correct O None of these answers are correct (o) (2 points) Suppose we assume that initially a = 0, b =0.5, Re = F =5%; if a, rises 2 percent and the real interest rate falls 2 percent, short-run output: O falls 2 percent O rises 1 percent O rises 3 percent O falls 1 percent ) does not change(g) (2 points) With adaptive expectations, the Phillips curve can be written as: O Am = DY O An = M-1+ muY On = Til + DY O Am = DI On = N-1 (h) (2 points) Which of the following best describes why the aggregate demand curve slopes downward ? O If the central bank observes a low rate of inflation, the monetary policy rule dictates an increase in the real interest rate. The high interest rate reduces output by reducing investment demand in the economy. O If the central bank observes a high rate of inflation, the monetary policy rule dictates a decrease in the real interest rate. The low interest rate increases output by reducing investment demand in the economy. O If the central bank observes a high rate of inflation, the monetary policy rule dictates an increase in the real interest rate. The high interest rate reduced output by reducing investment demand in the economy. O If the central bank observes a low rate of inflation, the monetary policy rule dictates a decrease in the real interest rate. The low interest rate reduces output by reducing investment demand in the economy. O None of these answers is correct. (i) (2 points) The adjustment process back to the steady state in the short-run model hinges on the: O rate of unemployment O immediate reaction to a change in the inflation rate consumers' response to inflation shocks government's response to inflation shocks O slow adjustment of inflation reflected in the aggregate supply curve. (j) (2 points) Which of the following represents the AD curve with a financial friction? On = a-bj - bin(n, - #). On = a (1 + 67) - bm(mt - #). On = A - bin(m - #) Oh = a - mf - bin(m - #)
