section 2

Question 1

what parameters in the IS curve equation will change the slope of the curve ?

Answer 1

b2 - sensitivity investment to IR

c1 - sensitivity consumption to income

Question 2

what parameters will shift the is curve ?

Answer 2

c0 - autonomous consumption

b0 - autonomous investment

Question 3

give an example of a shock to the is curve ?

Answer 3

all of a sudden investors lose confidence due to uncertainty over brexit

Question 4

do these types of shocks shift the Pc or move us along it

a. supply side shocks
b. demand side shocks

Answer 4

a. shift the curve

b. move us along it

Question 5

what is the loss function the government uses when it wants to minimise the variability of both unemployment and inflation ?

Answer 5

Lt = (Ut - U)^2 + gamma(piet - pie)^2

in our model U is directly inversely related to Y so we can rewrite as

Lt = (Yt - Y)^2 + gamma(piet - pie)^2

= Yt^2 + gamma.piet^2

Question 6

how to the government chose the value of gamma ?

Answer 6

it depends on what they value as more important unemployment stability of price stability

Question 7

in the 60s 2 main developments were popularised, the were called the forward looking theories of consumption. what were the two theories ?

Answer 7

friedman published the theory of consumption function 1957 which established the permanent income hypothesis.

franco modigliani and his intern developed the life cycle hypothesis

Question 8

how there these two new theories different to the keynesian consumption function previously used ?

Answer 8

KCF worked well on LR data but the PIH and LCh theory looked to reconcile the LR and SR results

PIH and LCH both assumed that

• individuals plan their future consumption
• and attempt to smooth their consumption over time

Question 9

describe freedman PIH in more detail

Answer 9

• splits income into two parts

permenant - regular income people expect throughout their lifetime

transitory - unexpected shocks that affect income (illness, lottery)

• has an infinite horizon

Question 10

describe modigilianis LCH in more detail

Answer 10

• individual households natural cycle
• the need to save fore retirement when income ceases
• has a finite horizon

Question 11

describe non human and human wealth ?

Answer 11

NON-HUMAN WEALTH
financial assets
non financial assets

HUMAN WEALTH
net present value of all future earnings

Question 12

compare a consumption function that involves only income vs wealth ?

Answer 12

INCOME
Ct = F(Yt)

only dependent on todays income, not very accurate

WEALTH
Ct = F(Wt)

overall future total wealth increases

Question 13

how do you calculate the perfect combination of consumption now and cons later ?

Answer 13

by maximising the constraint using the lagrangian method

just uses two utility functions

Question 14

what restrictions does calculating using the Lagrangian allow us to include ?

Answer 14

• interest rate
• inflation
• many smaller time periods
• infinite horizon
• borrowing constraints

Question 15

what do we assume for a 2 period model ?

Answer 15

(Y1 - C1) + r(Y1-C1) + Y2 < C2

savings1 interest1 income 2 consumption 2

Question 16

what is the inter temporal consumption choice ?

Answer 16

the choice between the utility functions

, how much consumption to put into each

Question 17

what is the inter temporal budget constraint ?

Answer 17

C2 = ( 1 + r )Y1 + Y2 / (1+r)

re arranged the assumption constraint

Question 18

in an indifference curve where C1 is the X axis and C2 the Y , which end of the curve do you spend more in which period ?

Answer 18

closer to the Y axis the more you spend in period 2 vs 1 and the opposite for closer to the X axis

Question 19

as real interest rates rise what happens to the intertemporal budget constraint for a lagrangian where there is no borrowing or saving , you just consume your current income ?

Answer 19

the IBC gets steeper by pivoting around the point where we consume all the current income in both periods ( where c1 = y1 and c2 = y2

Question 20

what is the consumption euler equation ? and where does it come from ?

Answer 20

c2 = c1(1+r)^2

comes from finding the foc of the lagrangian and equaling the L

Question 21

what equation do you get for C1 when you combine the consumption euler and IBC ?

Answer 21

C1 = ( Y1 + Y2/(1+r) ) / 2 + r

Question 22

what are some liquidity constraints ?

Answer 22

• you will not be able to borrow from the bank on the basis of future earnings. even if you can
• there will be an IR difference between borrowers and savers rates
• borrowing restraints introduce new constraints to our frame work
• more likely to be a problem if your consuming in period 2

Question 23

what is Austerity ?

Answer 23

• when the government spends G and receives T
• gov deficit = G-T
• any decision to affect the deficit is known as fiscal policy
• when the gov significantly reduces this it is known as AUSTERITY
• it is a situation where the gov spends as little money as possible because of a bad economic situation.
• the idea is to stabilise the economy through strict austerity

Question 24

what is the unconstrained minimisation problem ?

Answer 24

minimise brokers fees and lost bond earnings

£b . K + 1/2 . (£Y/K) . i

households and firms know brokers fees, income and IR

optimally chose a financial portfolio over time that balances the two forces

• need to call frequently enough to try and hold money in the bond as long as poss to max earnings
• need to not call too much so as to save money

Md*/P = root(Y.b/2i)

Question 25

how do expectations effect the inter temporal consumption function ?

Answer 25

households formed rational expectations of their future income and the ir they then chose a consumption plan that maxes the sum of their lifetime utility IBC = c1 = Y1 + Y2/(1+r) - C2/(1+r)

Question 26

explain how the (macro) minimal loss function is micro founded ?

Answer 26

``` households, max utility optimal q given P ( consumption euler) firms max profit subject to demand constraint new keynisan phillips curve minimum loss function, government ```

Question 27

how can the government manipulate the private sector to benefit the phillips curve ( relationship between inflation and un employment ) ?

Answer 27

the gov can announce its target and the private sector will believe this and then the gov can exploit a sr trade off between this good phillips curve by breaking its promise

Question 28

how can central banks achieve credibility ?

Answer 28

- make the central bank independent from the gov, this means it is separate from any political influences and resists political pressure to reduce unemployment - give incentives to the central bank to take into account the long term view, that it to take into account the long term costs of inflation - chose a conservative central banker who dislikes inflation

Question 29

what is the idea of ricardian equivalence ?

Answer 29

the idea that the government tax changes have no effect on aggregate spending . also known as the ricardo-barro proposition implies that consumers will not spend anymore of a tax cut than before - they will save all of it as long as G doesn't change T will have to increase by t + interest in the future, consumers recognise this and realising that the NPV of their lifetime has not changes, they do not adjust their consumption plan

Question 30

what is the ricardian equivalence not likely to hold in practice ?

Answer 30

the government lives forever, we don't, people without children who die before tax cuts are paid will benefit any reductions in tax rates may increase work incentives and increase future income and therefore confidence in spending there is also severe asymmetric information, households and firms cannot borrow at the same rate as the gov

Question 31

what are the governments two key fiscal rules that provide benchmarks against which the performance of fiscal policy can be judged ?

Answer 31

- the golden rule : only borrow to invest | - the sustainable investment rule : aim to keep debt : gap < 40%

Question 32

what is the taylor rule ?

Answer 32

a rule that the central bank can use in setting the base normal interest rate systematically responding to inflation and output/unemployment pin down the LR real IR it = i* + a(pie^et -pie*) + b(Yt - Yn) a - controls expected inflation because of time lags b - controls output/unemployment

Question 33

what does the PC look like for a. unemployment b. output

Answer 33

a. negativley sloped | b. positively sloped

Question 34

evaluate the taylor rule even with rational expectations ?

Answer 34

- in the SR the gov should use monetary policy to influence AD - fiscal policy should only be used in emergencies when we hit zero lower bound balance - is more political ( complex to use ) - has larger time lags , and ricardian equivelence means it may take too long to do too little - problem of time inconsistency can be avoided by committing to rules - taylor rules are a useful benchmark for conducting monetary policy - parameters need to be chosen based on welfare choice between inflation and unemlp , structure of econ - rules should still be supplemented with discretion because they run down long term real ir and economy parameters

Question 35

why is inflation bad ?

Answer 35

- shoe leather costs - tax distortions - money illusions - inflation variability = business and consumers uncertainty

Question 36

why is unemployment bad ?

Answer 36

waste of scarce resources | social costs

Question 37

what are the effects of austerity ?

Answer 37

- a un report says that austerity has directly increased poverty, especially for kids - there is some evidence to suggest an increase in mental health problems but its very hard t establish statistically - after the 2008 crisis our gap : debt ratio rose dramatically

Question 38

what are some effects of the uk leaving the eu ?

Answer 38

- being outside the customs union means higher import tariffs on eu exports - stopping freedom of movement in services, tech and construction will cause labour market shortages - delays at borders means costs will rise

Question 39

why should members of a monetary union be subject to constraints on their fiscal policy ?

Answer 39

- to correct the incentive to pass on fiscal expansion costs | - the prevent a crisis spreading to all the countries

Question 40

how do you reduce GDP : debt ratios ?

Answer 40

- generate sufficient primary surpluses : to do so the gov can cut spending and transfers and increase tax - resort to monetary financing from the central bank - repudiate ( default on ) the debt, in work or rent

Question 41

what is the auto regressive time series process ?

Answer 41

Yt = alpha + beta.Yt-1 Yt - gap:debt ratio alpha - deficit:gap ratio beta - in the absence of budget deficit or surpluses, this is the rate at which debt : gap grows ( 1 + r - g ) = if r > g it grows reverse reverse

Question 42

how do you calculate ... ? a. openness of an economy b. real exchange rate

Answer 42

a. (X+m)/Y | b. E = E.P/P*

Question 43

what are some trade barriers ?

Answer 43

tariffs quotas non tariff barriers

Question 44

what are some economic intergrations ?

Answer 44

``` free trade areas ( removal of tariffs ) customs unions ( common external tariffs , no border checks ) single markets ( harmonised rules and regulations , freedom of movement ``` the lower down the more integrated

Question 45

describe the foreign exchange market ?

Answer 45

- FOREX turns over about $5.3 trillion a day - the total size of the feds balance sheet is less an this even after QE so Goldman Sachs defiantly runs the world not central banks

Question 46

describe the uncovered interest parity ?

Answer 46

( 1 + it ) = ( 1 + i*t ) . ( Et / E^et+1 ) it - current domestic IR Et - current nominal ER i*t - current foreign IR E^et+1 - future expected nominal ER

Question 47

describe these types of exchange rates a. floating b. fixed

Answer 47

a. likely to be highly volatile , driven by investor speculation b. pegged - vulnerable to speculation attack monetary union - forces real IR to be same as all members