ECON 100 Tutorial: Week 24
Extra slides for exam revision
Ayesha Ali
a.ali11@lancaster.ac.uk
Office Hours: Tuesday 2:00-3:00, LUMS C85
Revision: True/False
Questions 1 – 25 from Last Year’s Week 24 Tutorial Worksheet
1. Interest paid to domestic holders of National Debt is included in the
National Income Accounts.
False (taxpayers are effectively paying themselves interest)
2. The amount of money, which economic agents in the aggregate
actually hold at any given moment, is necessarily equal to the amount
supplied.
True
3. The amount of money, which economic agents in the aggregate
actually hold at any given moment, is equal to the amount they
demand to hold.
False
4. If the amount of money held by individuals exceeds the amount they
demand to hold, Keynesian liquidity preference theory suggests that they
spend it on bonds.
True (and bond prices rise, implying that interest rates fall)
5. If the amount of money held by individuals exceeds the amount they
demand to hold, Friedman’s monetarist theory (neo-quantity theory)
suggests that they spend it on bonds.
False (answer is ‘goods and services, including imports, so that prices rise
generally - inflation)
6. In a world of fixed exchange rates and the absence of foreign exchange
controls, it would be impossible for a nation to pursue an independent
monetary policy.
True (If you fix the price, the amount supplied must be commensurate with
that price.)
7. Under the gold standard mechanism, gold imports make it more difficult
to export goods and services.
True (with an inflow of money, domestic prices rise)
8. Those who feel better off if earnings and prices increase by (say) 10%
suffer ‘money illusion’.
True
9. The original Phillips curve: an inverse relationship between real wages
and unemployment.
False
10. The expectations augmented Phillips curve hypothesis is that an inverse
relationship between percentage wage increases and unemployment exists
only where inflation is unanticipated.
True
11. Fiscal policy determines the magnitude of the PSBR.
True
12. An increase in the gold and forex reserves shows as a positive entry
on the capital account.
False (import of gold)
13. Individuals hold money for speculative purposes if they think bond
prices will fall.
True
14. The quantity theory of money states that an increase in the money supply will
ultimately cause a proportional increase in the general level of prices.
True
15. When the PSBR is increased, the money supply must also increase.
False (bond sales could accommodate the deficit)
16. When the PSBR is increased, the national debt must also increase.
True
17. The quantity theory of money implies that the velocity of circulation changes
to accommodate changes in the money supply.
False
18. Quantity theorists believe that money is an important determinant of the level
of real income.
False
19. Inflation is an upward prices adjustment to accommodate a higher
real resource costs.
False
20. Inflation is currency debasement.
True
21. Keynes said that ‘inflation is always and everywhere a monetary
phenomenon’.
False (Friedman said this)
22. Keynes’s speculative demand for money reflects the view that, in a
severe depression, monetary expansion is more likely to raise bond
prices than other prices.
True
23. The speculative demand for money is the need to have money to
make speculative purchases.
False
23. If residents of Eire bought petrol in Northern Ireland this would
show in respectively as a negative entry on Eire’s capital account and a
positive entry on the UK’s capital account.
False (Eire: current account import/capital account export; UK, vice
versa)
24. The demand to hold money is inversely related to the rate of
interest because when the interest rate is low people borrow money to
buy goods.
False
25. The natural rate of unemployment is that rate which is consistent
with ‘neutral’ money.
True
Exam 4
• Things to review:
• Past Exams (questions 30 – 40 approximately)
• http://www.lancs.ac.uk/sbs/registry/Exams/PastPapers/PastPapers.htm
• Lecture slides and/or recordings
• Tutorial Worksheet Problems that relate to class Lectures.
• Reading material
Past Exam Questions
2013, 2012, 2011, and 2010
Note: Solutions are not available to tutors.
Answers presented here are subject to error.
The hypothesis of the expectations-augmented
Phillips curve holds that:
a) employment contracts fully accommodate the rate of price inflation
b) job-seekers never make systematic errors
c) wage settlements are partially determined by the expected rate of price
inflation
d) reservation wages are determined by minimum wage legislation
2010 Exam Q32
Which of the following statement is true? With the
expectations-augmented interpretation of the
Phillips curve, Milton Friedman assumes that
a) monetary policy is the exogenous variable, that causes variations in
unemployment
b) trade union activity is the exogenous variable, that causes variations
in unemployment
c) unemployment is the exogenous variable, that causes variations in
inflation
d) monetary policy is the exogenous variable, used to counter
variations in unemployment
2013 Exam Q33
Expectations Augmented Phillips Curve
• Initially, unemployment and inflation
are at point A.
• Expansionist monetary policy would
increase consumption, shifting to
point B along the Phillips curve
• Unemployment is reduced but there is a
trade off; inflation.
• After a short period, agents will
associate expansionist policies with
inflation and will push for higher
wages. (Gerry: Price-wage spiral)
• This will stop the consumption
stimulus and also de-incentivise hiring.
Agents will shift their expectations
curves to point C.
The natural rate of unemployment is the level of
unemployment that is consistent with:
a)
b)
c)
d)
a high rate of inflation
low rate of inflation
an absence of monetary disturbance
an absence of involuntary unemployment
2010 Exam Q33
See Lecture 52
Natural rate of
unemployment (NRU)
NAIRU
Theoretical starting point
-Perfect competition
-Imperfect competition
Origins of deviation
-solely in labour market
rigidities
-in labour market rigidities;
-supply-side inflation
Inflationist mechanism
-monetary policies
-monetary policies;
-supply-side inflation
Type of unemployment
-voluntary (therefore NRU can
be assimilated to level of full
employment)
-voluntary;
-involuntary
-unique
-multiple equilibriums when
considering open economies
Uniqueness of equilibrium
The hypothesis of rational expectations contends that
individuals:
a)
b)
c)
d)
do not make systematic errors
anticipate future prices accurately
adapt slowly to the rate of inflation
only make rational errors
2010 Exam Q34
Rational Expectations:
• Rational expectations is a hypothesis in economics which states that
agents' predictions of the future value of economically relevant
variables are not systematically wrong in that all errors are random.
Identify the missing word(s): Goodhart’s Law states
‘that any ____I____ will tend to collapse once
pressure is placed upon it for control purposes.’
a)
b)
c)
d)
monetary target
observed statistical regularity
fiscal budgetary stance
structured investment
2010 Exam Q35
Goodhart’s Law
• Any observed statistical regularity will tend to collapse once pressure
is placed upon it for control purposes.
• (Goodhart's original 1975 formulation, reprinted on p. 116 in
Goodhart 1981[2])
Suppose that national income (measured in 1990 prices) is
£1000 billion. Suppose further that prices have doubled
since 1990 and that the typical unit of money circulates
around the economy 20 times per year.
What is the money supply?
a)
b)
c)
d)
£50 billion
£100 billion
£150 billion
£200 billion
2010 Exam Q36
MV = QP
We know that:
V = 20
Q = 1000
P=2
So, solving for M:
MV=PQ
M = QP/V
M = 1000*2/20
M = 100
Balance of International Payments Accounts
The general structure:
BoP
≡
X-M
BoP
≡ current account
income-expenditure
(deficit)
(surplus)
+
NB:
+ IOU (loan/credit)
≡0
+ capital account
≡0
∆wealth
≡0
(wealth falls)
+ (exporting assets or writing an IOU)
(wealth rises)
- (importing assets or receiving an IOU)
the current account surplus is matched by a
a ‘capital outflow’
If the LM curve is vertical, then:
a)
b)
c)
d)
full crowding out occurs
fiscal policy will be infinitely effective
monetary policy will not work
supply side policies will be unavailable
2010 Exam Q38
‘Crowding out’ occurs if new public expenditure
a) is insufficient to maintain social services
b) creates excess demand and over-full employment
c) attracts an influx of economic migrants
d) diverts expenditure from existing productive activities
2013 Exam Q31
Vertical LM curve
• If the demand for money is not related to the
interest rate, as the vertical LM curve implies,
then there is unique level of income at which
the money market is in equilibrium.
• Thus, with vertical LM curve, an increase in
government spending (which shifts the IS curve)
cannot change the equilibrium income and only
raises the equilibrium interest rates.
• If government spending is higher and the
output is unchanged, there must be an
offsetting reduction in private spending.
• In this case, the increase in interest rates crowds out
an amount of private spending equal to increase in
government spending.
• Thus, there is full crowding out if LM is vertical.
With Keynes’s speculative/asset demand to hold
money, speculation is in respect of a likely change in:
(a) the inflation rate
(b) the exchange rates
(c) bond prices
(d) equity prices
2012 Exam Q31
UK National Debt comprises:
(a) the sum of trade deficits over past years
(b) sterling currency notes and coins in circulation, plus commercial bank
deposits
(c) outstanding loans to the state, excluding sterling currency notes and
coins in circulation
(d) outstanding loans to the state, including sterling currency notes and
coins in circulation
2012 Exam Q32
As defined in Keynes’s General Theory, ‘involuntary
unemployment’ relates to individuals whose
employment prospects would be raised by:
(a) a rise in the price of wage goods (i.e., a rise in the cost of living)
(b) a fall in the price of wage goods (i.e., a fall in the cost of living)
(c) greater trade union participation
(d) a shift to capital-intensive production methods
2012 Exam Q33
As defined in Keynes’s General Theory,
‘involuntary unemployment’ relates to individuals
whose employment prospects would be raised by
a) a rise in the price of wage goods (i.e., a rise in the cost of living)
b) a fall in the price of wage goods (i.e., a fall in the cost of living)
c) greater trade union participation
d) a shift to capital-intensive production methods
2013 Exam Q30
Keynes on involuntary unemployment
• “Clearly we do not mean by ‘involuntary’ unemployment the mere existence of
an unexhausted capacity to work. An eight-hour day does not constitute
unemployment because it is not beyond human capacity to work ten hours. Nor
should we regard as ‘involuntary’ unemployment the withdrawal of their labour
by a body of workers because they do not choose to work for less than a certain
real reward. Furthermore, it will be convenient to exclude ‘frictional’
unemployment from our definition of ‘involuntary’ unemployment. My definition
is, therefore, as follows: Men are involuntarily unemployed if, in the event of a
small rise in the price of wage-goods [i.e., consumer goods] relatively to the
money-wage [i.e., nominal wage], both the aggregate supply of labour willing
to work for the current money-wage and the aggregate demand for it at that
wage would be greater than the existing volume of employment.”
If a UK resident citizen buys a BMW car from Germany
and the car exporter uses the payment to buy UK
government bonds, which of the following statements
would be true?
(a) UK net exports fall and net capital exports fall
(b) UK net exports rise and net capital exports rise
(c) UK net exports fall and net capital exports rise
(d) UK net exports rise and net capital exports fall
2012 Exam Q34
Net Exports
• If a UK resident citizen buys a BMW car from Germany
• This is a German export and UK import of a tangible good
• The car exporter uses the payment to buy UK government bonds
• This is a German import and UK export of a capital good
The original Phillips curve identified a robust
correlation between:
(a) unemployment and the rate of change of real wage rates
(b) unemployment and the rate of change of money wage rates
(c) wage levels and unemployment
(d) wage levels and inflation
2012 Exam Q35
Indicate which one of the following statements is
true. With the original interpretation of the
Phillips curve, A.W. Phillips assumes that
a) wage bargaining is the exogenous variable, that causes variations in
money wages
b) the business cycle (as reflected in the unemployment rate) is the
exogenous variable, that causes variations in increases in money wages
c) the real wage is the exogenous variable, that causes variations in
inflation
d) inflation is the exogenous variable, that causes variations in
unemployment
2013 Exam Q32
Phillips Curve
• Inflation is a
change in money
wages
According to Friedman’s re-interpretation of the
Phillips Curve, if inflationary expectations rise, the
Phillips curve:
a) shifts down
b) shifts up
c) becomes flatter
d) becomes steeper
2011 Exam Q32
Expectations Augmented Phillips Curve
• Initially, unemployment and inflation
are at point A.
• Expansionist monetary policy would
increase consumption, shifting to
point B along the Phillips curve
• Unemployment is reduced but there is a
trade off; inflation.
• After a short period, agents will
associate expansionist policies with
inflation and will push for higher
wages.
• This will stop the consumption
stimulus and also de-incentivise hiring.
Agents will shift their expectations
curves to point C.
If job seekers under-estimate the rate of inflation, the
duration of the job-search:
(a) shortens, so that unemployment tends to rise
(b) lengthens, so that unemployment tends to fall
(c) shortens, so that unemployment tends to fall
(d) lengthens, so that unemployment tends to rise
2012 Exam Q36
If job seekers under-estimate the rate of
inflation
• Then they will over-estimate the value of an offered wage contract
• And will accept a lower real wage
• And thus will have a shorter period of unemployment
Fiscal monetarists argue that inflation is a
consequence of excessive growth in:
(a) revenue from taxation
(b) national debt
(c) the money supply
(d) national output
2012 Exam Q37
Fiscal monetarists argue that inflation is a
consequence of excessive growth in
a) revenue from taxation
b) sovereign debt
c) the money supply
d) national output
2013 Exam Q36
The Taylor Rule is a representation of monetary policy
whereby the short-term nominal interest rate is
varied systematically with respect to:
(a) the trade deficit and the value of sterling
(b) employment and the cost of living
(c) inflation and the ‘output gap’
(d) tax revenues and the level of government borrowing
2012 Exam Q38
Taylor rule
The Taylor rule equation is written as:
rt = r* + π* + w(πt – π*) + (1 – w)(yt – y*)/y*
where:
rt is the central bank discount rate
πt is the inflation rate
π* is the inflation rate target
y is the GDP
y* is the potential GDP
w is the policy parameter
Define r as the real rate of interest and let r* be the
rate consistent with long run equilibrium in the
economy. Further, define π as the rate of inflation and
π* as the target rate of inflation.
Then r = r* + α(π – π*) is:
a)
b)
c)
d)
an LM curve
a Taylor rule
a DSGE model
incomprehensible
2010 Exam Q39
By the Taylor Rule, nominal interest rates are raised
whenever:
a) inflation falls
b) the output gap widens
c) the output gap closes
d) the inflation target is raised
2011 Exam Q36
By the ‘Lucas critique’, economic forecasts are:
(a) always unreliable
(b) most reliable when economic policy is stable
(c) most unreliable when a change in economic policy is implemented
(d) most unreliable when inflation is accelerating
2012 Exam Q39
According to the ‘Lucas critique’, economic
forecasts are
a) always unreliable
b) most reliable when economic policy is stable
c) most unreliable when a change in economic policy is implemented
d) most unreliable when inflation is accelerating
2013 Exam Q38
Theory of Economic Policy (Lecture 57 Slide 42)
Policy instruments and
objectives
New Classical Economics – the Lucas critique
Economic forecasts are most unreliable when they are most needed; i.e., when
a change in economic policy is to be implemented
Even if individuals’ expectations could be forecast in the context of current
policy structures, that ‘success’ is undermined when that policy structure
changes
New policy implies a new context in which decisions are taken: so individuals’
reactions
are affected
Behavioural adjustments to changes in policy structures emasculate
macroeconomic forecasting and (with it) aggregate demand management
Robert Lucas (1937 - )
Nobel Prize 1995 …
‘for having developed and applied the
hypothesis of rational expectations, and
thereby having transformed
macroeconomic analysis and deepened our
understanding of economic policy’
When the Bank of England undertakes quantitative
easing:
(a) long-term government bonds (gilts) are bought using newly created
money
(b) the composition of the national debt is altered
(c) the volume of the national debt remains constant
(d) all of the above
2012 Exam Q40
Quantitative easing is a process whereby a central bank:
a) sells long-term government bonds
b) purchases long-term government bonds
c) sells short-term government bonds
d) purchases short-term government bonds
2011 Exam Q35
What is quantitative easing?
• Expansionary monetary policy usually involves the central bank buying
short-term government bonds in order to lower short-term market interest
rates. If they keep doing this, it will eventually stop working – that is when
the economy is falls into a liquidity trap.
• A liquidity trap can occur when short-term interest rates are either at, or
close to, zero, so that normal monetary policy can no longer lower interest
rates.
(Zero is the lower bound on interest rates – meaning they can’t be
lower than zero – meaning bonds have to give at least a zero return.)
• This is when central banks use quantitative easing.
• Quantitative easing is when central banks purchase long-term assets
(including bonds, gilts, real estate) in an attempt to lower the long-term
interest rate and increase money supply.
Which of the following is not a function of the Bank of
England?
a)
b)
c)
d)
lender of last resort
supplier of money
acting as a store of value
determining the official interest rate
2010 Exam Q40
For UK international payments, the ‘balance for
official financing’ is the value of:
a) net exports including ‘invisibles’
b) foreign exchange reserves
c) net UK borrowing from foreign central banks
d) foreign exchange bought/sold to maintain the exchange value of sterling
2011 Exam Q38
The balance of international payments is
a) a corollary of the government’s overseas borrowing
b) a measure of an economy’s indebtedness
c) the overseas aid budget of a nation state
d) an accountancy identity
2013 Exam Q34
In the context of the balance of international
payments, a residual for ‘official financing’
indicates the extent to which the monetary
authority
a) sells domestic currency to increase holdings of foreign exchange reserves
b) sells foreign exchange reserves to support the value of the domestic
currency
c) allows the international value of its currency to be determined by market
forces
d) is taking advantage of a trade surplus to build its foreign exchange reserves
2013 Exam Q39
Balance of International Payments Accounts (Lecture 61 Slide 35)
The general structure:
BoP
≡ X - M + IOU (loan/credit)
≡0
BoP
≡ current account + capital account ≡ 0
BoP
≡ X - M + ‘invisibles’
BoP
≡ { balance for official financing } + Dforex
+ DLT + DST + Dforex
≡0
≡0
(exports of gold
and/or forex to
support £)
balance for official financing: the amount taken from (or absorbed by) official forex
reserves in order to stabilise the international value of domestic currency
With the Keynesian (liquidity preference) theory the
interest rate is determined by:
a) the asset demand to hold money
b) the speculative demand to hold money
c) expectations relating to future bond prices
d) all of the above
2011 Exam Q37
A nation with a fixed exchange rate cannot insulate
itself from world inflation because, if initially its
domestic inflation rate is lower than elsewhere:
a) economic recession forces domestic prices up
b) domestic goods become less competitive and cost-push inflation raises
domestic prices
c) domestic goods become more competitive which tends to increase
money in domestic circulation
d) none of the above
2011 Exam Q39
Under a fixed exchange rate
• Low domestic inflation will cause the price of goods to rise more
slowly than in other countries
• So other countries will seek to buy goods from the low inflation
country
• This will increase the amount of capital in the low inflation country
• This will put upward pressure on the low inflation country’s currency
‘Ricardo equivalence’: borrowing by the state is equivalent to ... I ...
(whether currently or else deferred by borrowing). Robert Barro set
Ricardo equivalence within the context of Keynesian macroeconomics,
where the implication is that ... II ... government expenditure gives no
boost to aggregate demand, since it is offset by ... III ... to meet ... IV ....
In order: missing words are:
I
a) raising taxation
b) reducing taxation
c) raising taxation
II
tax-financed
IMF-financed
High
III
spending
depreciation
default
d) raising taxation
bond-financed
saving
IV
living costs
borrowing costs
an exchange rate
target
future tax demands
2013 Exam Q35
The ‘Bank Rate’ (the key short-term rate set by the
Bank of England) is the repo rate. A repo is a
repurchase agreement whereby
a) a commercial bank sells the central bank a security, with an agreement to
repurchase that security, on a given date, at a higher price.
b) a commercial bank sells the central bank a security, with an agreement to
repurchase that security, on a given date, at a lower price.
c) the central bank sells a commercial bank a security, with an agreement to
repurchase that security, on a given date, at a higher price.
d) the central bank sells a commercial bank a security, with an agreement to
repurchase that security, on a given date, at a lower price.
2013 Exam Q37
A structural fiscal deficit exists when sovereign net
borrowing is
a) negative even as an economy is producing at full capacity
b) positive even as an economy is producing at full capacity
c) rising even when austerity measures are in place
d) negative even as an economy is producing at full employment
2013 Exam Q40