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MACROECONOMICS SECTION
Directions: Answer both parts, A and B; there is some choice in each part. Points will be
proportional to the time limits indicated.
Part A – Numerical Problems: Choose two (2) of the following. Time limit: 15 minutes each
(30 minutes total).
1. Assume the production function is Y = AK where A=7. The rate of depreciation is .05 and the
saving rate equals .20.
(a) What is the steady state condition in this model?
(b) Demonstrate numerically the 3-year growth path in this economy when the initial
value for K equals 1. [Show the transition between Kt and Kt+1.]
(c) Would it be a good policy to raise the saving rate in this economy? Explain or
demonstrate.
(d) Compare the impact of more saving in this model to the result in the Solow model.
2. Consider the following situation: the nominal interest rate on one-year dollar-denominated
assets equals .06 and the nominal interest rate on one-year euro-denominated assets equals .10.
Both assets have no default risk. The spot exchange rate, E, equals 1.30 euro per dollar.
(a) Investor A decides to invest in euro-denominated assets. Give a numerical example of
the rationale.
(b) Investor B decides to invest in dollar-denominated assets. Give a numerical example
of the rationale.
(c) Under what conditions would both investors be indifferent to dollar-denominated and
euro-denominated assets? Be specific.
3. Assume the public holds no currency and the ratio of reserves to deposits is 0.10. The demand
for money is: Md = $Y (.8 – 4i), where $Y is nominal GDP. Initially, the monetary base is $100
billion and nominal GDP is $5 trillion.
(a) What is the demand for central bank money?
(b) Find the equilibrium interest rate.
(c) What is the overall money supply?
(d) What is the impact on the interest rate if central bank money increases to $300
billion? Be specific.
(e) If the overall money supply increases to $3,000 billion, what is the new interest rate?
Part B – Long Answer Questions (Problems/Models) Choose two (2) of the following. Time
limits: 45 minutes each (90 minutes total)
1. Many countries enacted expansionary monetary policy in the wake of the onset of the
Great Recession. Analyze the situation of expansionary monetary policy for all three (3)
of the following cases, assuming a short-run analysis. Your analysis can be mainly
graphical and must include detailed explanations. You may include equations if you wish.
Also, you must show and explain the changes on the central bank balance sheet where
relevant.
a. IS-MP model, closed economy, where MP is the “monetary policy” curve
assuming the central bank targets the interest rate.
b. Open economy IS-LM model, with free capital mobility (so that the interest parity
relation holds) and a flexible exchange rate. Explain in detail the role of the
interest parity condition.
c. Open economy IS-LM model, with free capital mobility (so that the interest parity
relation holds) and a fixed exchange rate. You must explain in detail the role of
the interest parity condition. Could the policy trilemma be relevant in this case?
Explain.
d. Finally, compare the impact on real GDP across the scenarios and explain
carefully.
2. Analyze the short-run and medium-run effects of each of the following on output and the
price level, using the IS-LM model and the aggregate-supply/aggregate-demand model
(AS-AD). Be sure to explain how the economy adjusts from the new short-run
equilibrium to the new medium-run equilibrium, discuss in detail the role of price
expectations, and assess whether the theoretical adjustment process is realistic or not in
each case. You may assume that the economy starts in an initial medium-run equilibrium
at the “natural” output level Yn in each situation.
a. An increased level of enforcement of anti-trust laws.
b. A reduction in the level of unemployment benefits.
c. An increase in consumer wealth.
3. (a) Derive the Solow Growth model (neoclassical growth model) algebraically.
(b) Explain intuitively the steady-state equilibrium condition in the Solow Growth model.
(c) Use the graph of the Solow model to analyze the effects of each of the following
changes (considered separately) on long-run equilibrium:
(i) A decline in the growth rate of the population
(ii) A rise in the saving rate
(iii) An increase in the rate of technical progress
For each case, what is the change in the growth rate of output, output per worker, and
output per effective worker? Summarize and explain the reasoning.
(d) Finally, consider whether or not a policy to reduce the saving rate would be a good
idea (e.g. is it possible for an economy to have too much capital?).
4.
The euro-zone has a significant risk of deflation, with a few of its members already
experiencing deflation.
(a) Define deflation and explain how it develops.
(b) What is the risk to economic performance from deflation?
(c) Consider the closed economy IS-LM and AD-AS model and analyze the short run and
medium run implications of deflation for real GDP, interest rates and the price level.
Provide a detailed explanation.
(d) How should monetary and fiscal policy be used (if at all)? Provide a detailed
explanation.
(e) Would deflation affect the debt burden of the euro-zone economies? Explain
carefully.