Economics

Exam 2

Macroeconomic Theory

(Due date: May 14, 10 am)

This is a take home exam. Do not communicate with others and work on the exam by yourself.

This is an open book exam and you can study the background materials from your textbook and

lecture materials, but you must write your own answers by yourself.

Due date and time: May 14, 10 am. You must submit it through blackboard only. Please do

not submit it any other way. Blackboard will not accept the answer after the due date and time

so you must submit it by that time.

Multiple choices (1 point each)

1. What is ‘the’ main monetary policy tool available to the Federal Reserve (recall MP curve)?

a. reserve rate

b. discount rate

c. federal funds rate

d. printing money

e. mortgage rate

2. The federal funds rate is:

a. equal to the rate of inflation.

b. the interest rate at which banks borrow from the Federal Reserve.

c. the interest rate paid from one bank to another for overnight loans.

d. an interest rate that is some fixed amount above the prime lending rate.

e. the return to stock markets over the long term.

3. Which of the following is the Fisher equation?

a.

d.

b. e.

c.

4. Consider the economy presented in Figure 12.2. If the stock market drops sharply, there is a loss

in consumer and investor confidence and the economy moves from __________. To prevent a

__________, the Fed __________, and the economy moves from __________.

a. point a to d; recession; lowers interest rates; point d to b

b. point c to b; bubble; raises interest rates; point b to c

c. point d to c; recession; lowers interest rates; point c to b

d. point a to d; recession; lowers interest rates; point d to c

e. Not enough information is given.

5. The Phillips curve we specified assumes that inflation expectations are:

a. Rational d. equal to zero

b. Adaptive e. None of these answers are correct.

c. always wrong

6. According to the Phillips curve, if current output equals potential output (with no inflation shock):

a. inflation is steady d. unemployment is negative

b. inflation fluctuates a lot e. the economy is booming

c. unemployment is zero

7. According to the Phillips curve, if current output is above potential output (with no inflation shock):

a. inflation falls d. inflation is constant

b. inflation rises e. tax rates rise

c. unemployment falls

8. According to the Phillips curve, if current output is below potential output (with no inflation shock):

a. inflation falls d. inflation is constant

b. inflation rises e. tax rates rise

c. unemployment falls

Figure 12.4: Phillips Curve

9. Consider the Phillips curve in Figure 12.4. At point b, the economy is ________, and at point a, the

economy is ________.

a. in recession; booming

b. in recession; in its steady state

c. in recession; in recession

d. booming; in recession

e. in its steady state; in recession

10. In the Phillips curve, ∆𝜋𝑡 = �̅��̃�𝑡 + �̅�, �̅� measures: a. a price shock

b. how sensitive inflation is to interest rates

c. how sensitive inflation is to demand conditions

d. how sensitive inflation is to aggregate supply conditions

e. how sensitive inflation is to price shocks

11. In the Phillips curve ∆𝜋𝑡 = �̅��̃�𝑡 + �̅�, �̅� measures: a. a demand shock

b. an inflation shock

c. how sensitive inflation is to demand conditions

d. how sensitive inflation is to aggregate supply conditions

e. None of the above

Figure 12.5: Phillips Curve

12. Starting from any point in the Phillips curve in Figure 12.5, an unexpected increase in oil prices will

move the economy from (everything else is constant):

a. point a to b d. point a to c

b. point c to b e. Not enough information is given.

c. point b to c

Short answer questions

Please write clearly. If I cannot understand your writing, I cannot give you the credits for the

questions.

1. Your day as the chair of the FED: Suppose you are appointed as the chair of the US Federal

Reserve. “With the sole goal of stabilizing output”, explain how and why you would change the

interest rate in response to the following shocks. Show the effects on the economy in the short

run using the IS-MP diagram. Be sure to discuss what changes in the model specifically. Provide

detailed intuitive explanation in words as well. (You can assume that the economy, before the

shock, is at the benchmark point.) (12 points)

A. Firms become pessimistic about the state of the economy and hence decrease the investment.

(Note that this happens initially without any change in the interest rate).

B. Suppose some of Latin American economies succumb to a recession and significantly reduce

their demand for the U.S. goods.

2. Your day as the chair of the FED: Suppose you are appointed as the chair of the US Federal

Reserve. “With the sole goal of stabilizing inflation at a low level”, explain how and why you

would change the interest rate in response to the following shock. Show the effects on the

economy in the short run using the US IS-MP-and Philips curve diagrams. Provide detailed

intuitive explanation in words as well. In your analysis, be sure to discuss how FED can

stabilize the inflation at the level that they desire. (You can assume that the economy, before the

shocks, is at the benchmark point.) (10 points).

Suppose France experiences a boom and significantly increase their demand for the U.S. goods.