EXAMINATION PAPER Examination Session: May/June Year: 2020 Exam Code: ECON2011-WE01 Title: MACROECONOMICS Time Allowed: 1 hour 30 minutes Additional Material provided: None Materials Permitted: None Calculators Permitted: No Visiting Students may use dictionaries: Yes Instructions to Candidates: This exam consists of two parts each carrying 50% of the overall mark. Answer all sections from part A and two questions from part B. Each question and each sub-part of a question is equally weighted unless otherwise stated Revision: Page 2 of 3 ECON2011-WE01 Part A Answer ALL sections: 1. a) Given a Lucas surprise supply function = ̅ + ( − ) + (where is an unbiased random shock), assume that the policy maker minimises a loss function of the form: = [ − (̅ + )]2 + 2( − ∗)2. In equilibrium are the expected rate of inflation e and the ideal one going to be the same and if not by how much will they differ? b) Assuming an open economy where wage bargaining finds its equilibrium independently of import prices (which implies a vertical ERU curve as in Carlin & Soskice 2014), and ignoring short-term dynamics, illustrate with a diagram how the medium-run equilibrium real exchange rate is affected by a permanent positive supply shock. c) Derive the change in technology in a Real Business Cycle model by means of the Solow residual, assuming the following production function: = 1− d) An agent lives for 2 periods and gains utility from consumption. The agent discounts future consumption at rate ρ where 0< ρ <1. The agent consumes and saves at interest rate in the first period of life from income w. In the second period, the agent consumes from an income w as well as savings plus interest earned. i. Find the Euler equation for this agent. ii. Explain and show on a diagram what happens to the path of consumption when r decreases. Part B 2. Consider a government dynamic budget constraint in debt to GDP terms. a) Why is the stability of this equation a matter of concern? b) How do rating agencies affect the equation and its stability? c) This approach maintains that the government budget constraint is effectively comparable to that of a household. What insight do we gain from such a comparison and what are its limitations? 3. Consider a model of an economy with an explicit banking sector as in Howells (2009). a) What problems does the existence of the Zero Lower Bound in the setting of the policy rate create? b) How can we introduce balance sheet liquidity considerations and the effect of securities markets? c) Why would Minsky maintain that such a financial structure inevitably generates cycles? 4. Consider a Real Business Cycles model of the economy. a) What are its defining assumptions? b) How does it fare in terms of internal and external consistency? c) Why do some economists consider it implausible as an explanation of observed cycles? CONTINUED Page 3 of 3 ECON2011-WE01 5. Consider the economy described in part A section d. a) The agent described is now embedded in an Overlapping Generations model. Solve the representative agent’s problem. Describe how agents “overlap” within this framework. b) Solve the firm’s problem by finding the factor remunerations of capital and labour. c) Find the competitive equilibrium of this model. 6. Consider a micro-founded model of the Macro-economy where agents are endowed with Rational Expectations. a) Why are some economists dissatisfied with the answers such a model provides? b) Does Complexity theory fare any better? c) Does Post-Keynesian theory fare any better? END
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