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ECON2011
Macroeconomics
Release Date/Time 12th May 09.30
Latest Submission Date/Time 13th May 09.30
Format of Exam Take home exam
Duration: 2 hours
Word/Page Limit: 2000 words
Additional Material provided: None
Expected form of Submission Word Document using template provided or PDF of Handwritten
Work.
Your uploaded file should be named with your Anonymous
Code and the Exam Code e.g. Z0123456 ECON2011-WE01
Submission method Turnitin
Instructions to Candidates: This exam consists of two parts each carrying 50% of the
overall mark. Answer all sections of Question 1 in part A and
two questions from part B.
Each question and each sub-part of a question is equally
weighted unless otherwise stated.
Page 2 of 6 ECON2011-WE01
continued
Part A
1. The answers submitted to the following four questions are all wrong in one or more ways.
You should work out the correct answer explaining why the given one was wrong and why
yours is instead correct. Answer ALL sections:
a) An economy is described by an Inertia Augmented Phillips curve of the form: = −1 +
(−1 − ). The policy-maker minimises an objective functions given by: = ( − )
2 +
(+1 −
)2 and sets an interest rate that affects the real economy according to: ( − ) =
−(−1 −
). Derive the interest rate rule followed by the policy-maker.
= ( − )
2 + ( + ( − ) −
)2
= −2( − )
2−1 − 2( + ( − ) −
)2−1 = 0
(1 + )( − ) = −(−1 + (−1 − ) −
)
( − ) =
−(−1 − ) − (−1 −
)
(1 + )
−(−1 −
) =
−(−1 − ) − (−1 −
)
(1 + )
(−1 −
) =
(1 + )
[(−1 − ) + (−1 −
)]
Page 3 of 6 ECON2011-WE01
continued
b) Assuming a closed economy, illustrate with a 3-equations diagram how a permanent negative
demand shock may set the economy onto a deflationary spiral which cannot be halted by
changes in the interest rate.
continued
c) Illustrate with a diagram how in a closed economy 3-equations model with an added banking
sector (Howells 2009) the central bank would bring the economy back to target after a
temporary positive demand shock, assuming a smooth and reliable transmission of policy
changes.
continued
d) An agent lives for 2 periods and gains utility only from consumption. The agent
discounts future consumption at rate θ where 0< θ <1. The agent consumes
and saves at interest rate in the first period of life from income y. In the
second period, the agent consumes from savings plus interest earned but must
pay a fixed flat tax.
i) Find the Euler equation for this agent and explain what it shows.
ii) Explain what happens when the size of the tax decreases
Part B
2. Consider a government’s dynamic budget constraint in debt to GDP terms.
a. Analyse why policy-makers have been concerned about the stability of this equation,
and what policy rules have been implemented to address these concerns.
b. Why has the Reinhart and Rogoff (2010) result proven to be so controversial?
c. Analyse why a consensus on these is unlikely to emerge soon.
3. Consider the economy described in part A section c.
a. Under what conditions would a higher liquidity preference make commercial banks
reluctant to lend?
b. Assuming that the conditions under a) now hold, can policy measures be put in place
to avoid a recession?
c. Why does Minsky’s financial instability hypothesis modify the analysis?
4. Consider a Real Business Cycles model of the economy.
a. Analyse its theoretical structure, its crucial assumptions, and its objectives.
b. What are the implications of its being a calibrated and not an estimated model?
c. Assess at least two reasons why this class of models has come to be rejected as an
implausible account of how the economic cycle develops.
5. Consider the economy described in part A section d.
a. The agent described is now embedded in an Overlapping Generations model.
However, there is no tax. Solve the representative agent’s problem if the agent’s utility
is in log form. Describe how agents “overlap” within this framework.
b. Solve the firm’s problem by finding the factor remunerations of capital and labour if the
production function is Cobb-Douglas.
c. Find the competitive equilibrium of this model and comment on the effects of a
decrease in θ.
6. Consider a representative-agent rational-expectations model of the economy.
a. Analyse which features of the macro-economy such a model would be structurally
incapable of explaining.
b. Has Complexity Economics provided an improvement and how?
c. Has Post-Keynesian Economics provided an improvement and how?