EC360

Expansive fiscal policies that reduce the budget surplus, make domestic bonds relatively less attractive than foreign bonds and, hence, depreciate the currency.

True, expansive policies decrease the interest rate and because of the uncovered interest parity condition the currency depreciate

The saving rate it is always equal to the investment rate. .

True, in a closed economy, and if saving includes public and private saving

Explain whether it is possible for nominal GDP to increase and real GDP to decrease in the same period.

Nominal GDP can rise because either the price level is rising or the real quantity of goods and services produced has increased. Nominal GDP can increase while real GDP falls if the increase in the aggregate price level is larger (in a proportionate sense) than the drop in real economic activity.

The main channel of the international transmission of the 2008 crisis was via falls in wealth from falling house prices and stock markets.

False

The original Philips curve relation had proven to be very stable across countries and over time

False

Opening the economy to trade tends to increase the multiplier because an increase in expenditure leads to more export.

False - multiplier becomes smaller

The natural rate of unemployment is the same in all countries.

False, differences in natural rate of unemployment may explain persistent differences in unemployment performances across countries

The natural Rate of Unemployment is unaffected by policy changes.

False, it can be changed with supply side policies and labor market reforms

The increase in domestic output following a fiscal expansion abroad is higher the higher the foreign propensity to import, and the higher the domestic propensity to import.

False, it is higher only for the foreign propensity to import

A farmer sells wheat to a baker for £2. The baker uses the wheat to make bread, which is sold for £3.

False, only final goods count towards GDP

The price of bonds increases when the interest rate rises.

False, there is an inverse relationship between price of bonds and interest rate

In a bank liquidity crisis credit spreads narrow considerably.

False- spreads widen

GDP is the value of all goods and services produced in the economy.

False. GDP = Gross Domestic Product GDP = Value of FINAL goods and services produced in the economy.

A real depreciation leads to an immediate improvement of the trade balance.

False. According to the Marshall-Lerner condition, depreciation makes the domestic goods more competitive with respect to foreign goods, so exports increase and import decrease, causing an improvement in the trade balance. This effect is reached only after some time: in the short run the relative increase in foreign prices makes the imports more expensive and the trade balance decreases.

Capital Accumulation does not affect the level of output in the long run, only technological progress does

False. Capital formation cannot sustain growth alone but it does contribute to long-term growth.

In the steady state, output per effective worker grows at the rate of population growth.

False. In steady state, there is no growth of output per effective worker.

The central bank can increase the supply of money by selling bonds in the bond market

False. The Central Bank can increase the supply of money by buying bonds.

The LM curve is upward sloping because a higher level of the money supply is needed to increase output.

False. The LM is upward-sloping because in equilibrium, an increase in the level of income increases the demand for money and the interest rate to ensure that Md/P = YL(i) = M/P = constant

The demand for money does not depend on the interest rate because only bonds earn interest.

False. The demand for money is given by the consumer's choice between holding money or bonds, so it depends by the interest rate

A higher investment rate can sustain higher growth of output forever.

False. The economy will eventually reach a steady state where output per worker does not increase

If people assume that inflation will be the same as last year's inflation, the Philips curve relation will be a relationship between the change in inflation rate and the unemployment rate

False. The original Philips curve delineates the relationship between inflation and unemployment

A higher saving rate implies a higher level of capital per effective worker in the steady state and thus a higher rate of growth of output per effective worker.

False. The steady-state rate of growth of output per effective worker is zero. A higher saving rate leads to higher steady-state level of capital per effective worker, but has no effect on the steady-state rate of growth of output per effective worker.

When the unemployment rate is high, the participation rate is likely to be high.

False. When the unemployment rate is too high, some of the unemployed give up looking for a job and exit the labour force, so the participation rate is lower.

If government spending and taxes increase by the same amount, the IS curve does not shift.

False: An increase in taxes would shift the IS curve to the left, while an increase in government spending would shift the curve to the right, but the effect on the output will not be the same. Y will increase of 1 unit if both G and T increase by 1 unit each,

The demand for money depends on the real interest rate

False: The (nominal) demand for money depends on the nominal interest rate

If all the exogenous variables in the IS relation are constant, then a higher level of output can only be achieved by lowering the interest rate.

True

If the Rate of technological progress increases, the investment rate must increase to keep capital per effective worker constant.

True

The aggregate production function is the relationship between output on the one hand and labour and capital on the other

True

The reservation wage is the wage that would make workers indifferent between working and being unemployed.

True

Writing the production function in term of capital and labour implies that as the level of technology increase by 10%, the number of worker required to achieve the same level of output decreases by 10%.

True constant return to scale

Excluding the southern European outliers of Greece, Italy, Spain and Portugal unemployment rates across Europe are fairly similar

False

The AS curve is upward sloping because producers sell more goods when the price is high

False

The ILO definition of unemployment measures unemployment as the number of people claiming unemployment benefit in each country.

False

Franklin Roosevelt became the US President in 1933. In the period after he became the president: The federal government deficit increased to 5.6% of GNP in 1934. The short-term nominal interest rate fell from 1.7% in 1933 to 0.75% in 1935. The CPI fell by 5.2% in 1933 and rose by 3.5% in 1934. The US left the gold standard in April 1933. The New Deal was launched in 1933 and included proposals to increase federal government spending in a wide range of programs and reforms to the banking system. Which of the following statements is correct regarding the years immediately after Roosevelt became the US president? a) A change in the expectations of consumers of their future earnings, as a result of the New Deal, would have contributed to an expansion in the economy's aggregate demand. b) The value of the US dollar increased as the result of the abandonment of the gold standard and allowed the nominal interest rate to be cut to close to zero. c) The real interest rate rose after 1933. d) Fiscal contraction from the increased government deficit would have contributed to the economy escaping from the Depression.

A is correct as More optimistic expectations lead to increased consumer spending

floating exchange rate

A system under which the exchange rate for converting one currency into another is continuously adjusted depending on the laws of supply and demand.

exogenous variable

A variable that is assumed not to depend on the state of the economy—that is, it does not change when the economy changes.

fixed exchange rate

An exchange rate policy under which a government commits itself to keep its currency at or around a specific value in terms of another currency or a commodity, such as gold.

2. Herbert Hoover was the US President between 1929 and 1933. During this time: President Hoover advocated a balanced budget which remained within the range of -0.6% to +0.8% of GNP in 1929-31. Output was 20% below the full employment level in 1931. The short-term nominal interest rate fell from 5.8% in 1929 to 1.7% in 1933. The CPI decreased from -2.7% in 1930 to -10.3% in 1932. The US remained on the gold standard while the UK abandoned the regime in 1931. Which of the following statements is correct regarding this period? Select one answer a) The government's balanced budget contributed to the stabilisation of the economic activity. b) Despite the cut in the nominal interest rate, monetary policy was contractionary during this period. c) The cut in the nominal interest rate was possible due to the US remaining in the gold standard. d) The fact that the UK left the gold standard made it easier for the US to remain in the gold standard

B is the correct answer

4. The following describes the golden age of 1948 to 1973: The size of the government grew throughout the 1950s and 1960s. Workers' trade unions and political parties were in a stronger position to bargain for a share of the productivity gains. The modern welfare state was built in the 1950s, including the introduction of unemployment benefits. The gold standard was replaced by the Bretton Woods System. Which of the following statements is correct regarding the golden age? a) Government increased in size, which made government decision-making too rigid, which in turn hindered economic expansion. b) The stronger bargaining position of workers meant that they would mostly support innovation, despite temporary job destruction. c) The introduction of unemployment benefits led to higher inflation, destabilising economic growth. d) The Bretton Woods System made it more difficult to devalue currencies, leading to stabilisation of capital flows which contributed to economic growth.

C is correct toward the end of the golden era

The incidence of youth unemployment is only higher in Europe in countries with higher than average unemployment rates such as Greece, Italy, and Spain.

False

Which of the following statements is correct regarding the golden era? a) The rise in the wage-setting curve due to stronger trade unions and higher unemployment benefits led to post-war innovation. This shifted the price-setting curve up. b) A rise in the wage-setting curve depresses profits and reduces investment. This conflict of interest between workers and employers means that low unemployment, high profits, and high investment would not have been sustainable. c) The substantial increase in the bargaining power of trade unions and political movements allied with workers meant that they could demand the highest possible wages, pushing the wage-setting curve to its highest possible level. d) Continuing technological progress owing to widespread expectations of sustained high profits, together with high wages resulting from the strong bargaining power of trade unions, created a virtuous circle of high investment, rapid productivity growth, rising wages, and low unemployment.

D

It is never in the interests of employers to pay wages above the reservation wage.

FALSE

A recession is often defined as three consecutive quarters of negative growth in GDP.

FALSE - A recession is often defined as TWO consecutive quarters of negative growth in GDP

Prior to 2008 interest rates were too low in both the USA and Europe because inflation was well above target.

FALSE -Inflation typically on target

The marginal propensity to consume is the change in consumption expenditure divided by the percentage change in income.

FALSE -change in C divided by change in income.

Suppose that over the past decade, U.S. inflation is greater than that in Japan. Further assume that during this same period, the dollar depreciates relative to the Japanese yen. Given this information the dollar real exchange rate must have appreciated.

FALSE uncertain

If an economy shifts from lump-sum taxes to income taxes, an increase in government spending will result in a greater increase in GDP.

FALSE. An income tax is an automatic stabilizer which reduces the multiplier

Workers who are not members of trade unions have no bargaining power.

FALSE. Blanchard suggests non-union bargaining power determined by (i) cost to the employer to replace you (ii) the availability of another job

Discouraged workers are those who shirk due to their low wages.

FALSE. Desire a job and to work but discouraged from searching as no jobs available.

An appreciation of the real exchange rate means that the nominal exchange rate must also have appreciated.

FALSE. Domestic prices may be rising fasting than foreign prices

Is it possible for nominal GDP in a year to be less than real GDP in the same year?

Nominal GDP represents the value of goods and services produced using current prices. Real GDP measures the value of the same goods and services using some base year prices. It is possible for nominal GDP to be less than real GDP in a given year. Given the definitions of the two variables, this will occur if prices in that year are simply less than prices in the base year. If, for example, the base year is 2002, it will generally be the case that nominal GDP will be less than real GDP for those years prior to 2002 given that prices have generally risen in all years.

An appreciation of the domestic exchange rate is an increase in the price of the domestic currency in terms of foreign currency.

TRUE

Sclerosis is an economic term to describe markets that function poorly and have few transactions.

TRUE - Unemployment = inflow x duration. For a given unemployment rate Sclerotic labour markets have low inflow and low duration relative to other labour markets

If the marginal propensity to save increases, the multiplier will decrease.

TRUE.

If everyone increases their marginal propensity to save, the Keynesian model predicts that total saving will not increase.

TRUE. This is the paradox of thrift

The multiplier (Keynesian multiplier) is always greater than 1 if T = 0 and G = 0.

TRUE. goods market equilibrium implies:

2. Which of the following statements is correct? a) participation rate = employed ÷ labour force b) unemployment rate = unemployed ÷ population of working age c) employment rate = employed ÷ population of working age d) employment rate + unemployment rate = 1

The correct answer is C. participation rate = labour force ÷ population of working age unemployment rate = unemployed ÷ labour force unemployment rate = unemployed ÷ labour force, while employment rate = employed ÷ population of working age. They do not add up to 1 because the denominator is different.

paradox of thrift

The idea that when many households simultaneously try to increase their saving, actual saving may fail to increase because the reduction in consumption and aggregate demand will reduce income and employment.

An increase in the propensity to consume will increase the value of the expenditure multiplier.

True, the multiplier in a closed economy is 1/(1-c) so if the propensity to consume increases it increases the value of the multiplier.

A small open economy can reduce its trade deficit through fiscal contraction at a smaller cost in output than can a large open economy.

True. A fiscal contraction reduces the domestic demand of goods, thus reduces the value of imports, and improves the trade balance, but at the cost of lower domestic demand of domestic goods and lower output. The more open the economy, the larger the effect on the trade balance and the smaller the adverse effect on output. The cost is inversely

The central bank can determine the money supply or interest rates but not both at the same time.

True. Cannot control both the price and quantity of money at the same time in a free market.

If capital never depreciated, growth could go on forever

True. In the model without depreciation, there is no steady state. A constant saving rate produces a positive but declining rate of growth. In the infinite- time limit, the growth rate equals zero. Output per worker rises forever without bound. In the model with depreciation, if the economy begins with a level of capital per worker below the steady-state level, a constant saving rate also produces a positive but declining rate of growth, with a limit of zero. In this case, however, output per worker approaches a fixed number, defined by the steady-state condition of the Solow model. Note that depreciation is not needed to define a steady state if the model includes labour force growth or technological progress.

In Blanchard's IS-LM model given a fixed supply of money, an increase in government spending leads to a decrease in investment.

True: An increase in government spending leads to an increase in income, resulting in a rise in demand for money and a rise in the interest rate. The rise in the interest rate decreases investment

In the standard IS-LM model Government policy can increase output without changing the interest rate only if both monetary and fiscal policy variables change.

True: In normal circumstances this is true

If all the exogenous variables in the IS relation are constant, then a higher level of output can only be achieved by lowering the interest rate.

True: This occurs through changes in endogenous investment relation I (Y, i)

The rate of inflation computed using the CPI is a better index of inflation than the rate of inflation computed using the GDP deflator.

Uncertain

Monetary contraction and fiscal expansion increase equilibrium output and the interest rate.

Uncertain, the total effect on output depends on the relive shift of the IS and LM

The higher the saving rate, the higher consumption in the steady state.

Uncertain. See the discussion of the golden-rule saving rate.

The demand for money depends on the real income.

Uncertain. The nominal demand for money depends on nominal income and the real demand for money depends on real income. £Md = £YL(i) or M/P = YL(i)

Surprisingly, if the government hires a completely useless paper shuffler, GDP increases, but if General Motors hires this person, GDP remains unchanged, as it should. Is this correct? Explain your reasoning.

Yes, this is correct. Government spending on this person is considered a final output and is valued at its cost. General Motors' spending is an intermediate output and so is not counted: this wage income is offset by a fall in General Motors'profit.

Phillips Curve

a curve that shows the short-run trade-off between inflation and unemployment

liquidity trap

a situation in which conventional monetary policy is ineffective because nominal interest rates are close to zero and savings rates are high. Therefore monetary policy is ineffective since nominal interest rates cannot fall below zero.

endogenous variable

a variable that is determined within the model

During a liquidity trap:

consumers choose to avoid bonds and keep their funds in savings because of the prevailing belief that interest rates will soon rise (which would push bond prices down)

Leaving aside statistical measurement error, the sum of the current account and the capital of balance of payments is either positive, negative or zero.

false

Fire-sales is a term used to describe the major expansion in mortgages issued in the US sub-prime market.

false- Fire-sales refers to mass sales of assets by bonds which reduced asset prices further

In a closed economy the equilibrium conditions are:

income equals aggregate demand for goods and money supply equals money demand.

In a floating rate exchange rate regime, expansionary fiscal policy:

increases output and then the output decreases to the original level.

In an IS-LM model, an expansionary fiscal policy:

increases output.

When the economy is in a liquidity trap and the transactions motive is satisfied:

people prefer to hold money than bonds.

The nominal exchange rate is the:

price of domestic currency in terms of foreign currency.

The natural rate of unemployment is the:

rate of unemployment towards which the economy gravitates in the long run given all the labour market imperfections.

A policy aimed at lowering the natural rate of unemployment should:

reduce either the rate of job separation or increase the rate of finding a job.

Inflation is the:

the percentage change in the level of prices

Leaving aside statistical measurement error, the sum of the current accounts of the balance of payments for all countries in the world must be zero.

true

The bank leverage ratio measures the ratio of assets to capital.

true

The Phillips curve is a relation between

unemployment and unexpected movements in the inflation rate.

Income and wealth are both examples of stock variables

wealth is a stock since it can be measured at a point of time, but income is a flow because it can be measured over a period of time. Examples of stocks are: wealth, foreign debts, loan, inventories (not change in inventories), opening stock, money supply (amount of money), population