5.9 financial markets and central bank online test | Business & Finance homework help

ExamAdvice.docx

Exam Advice

The ECON3507 exam will take place in May (date still to be confirmed)

The exam is online. The exam paper will be open for 24 hours, opening at 9am on one day, and closing at 9am a day later, by which time you should have submitted to the Turnitin link provided on LearningZone.

There is a draft exam paper which has the same structure as the one you will be set.

You will see that there is a first section with four questions, of which you must choose two to answer.

There is then a second section with a single longer question that you must attempt.

Generally questions are non-technical, not requiring lots of Maths or diagrams, but rather expect you to explain the concepts and apply them to specific examples as you did in the coursework and as we have done in the seminars throughout the course.

The longer question will require you to do research and find information to fully answer it.

If you need to draw diagrams, you can do this by hand and insert a picture. Please make sure these are tidy, similarly for any maths you may use or other tables or graphs.

Topics

The following broad topics are part of the exam and should be the focus of your revision:

· Demand and Supply of Money

· Exchange rates, including fixed exchange rates and the Euro

· Interest rates and Inflation

· Desirable properties of Central Banks

· Business cycles and central bank objectives.

How to prepare

· Attempt the mock exam – get feedback from friends and tutors

· Come to your remaining classes and lectures which include revision advice for the exam

· Seek help from your tutors

· Go over relevant lectures, reading and seminar questions from the course, make sure you understand.

· Look again at your feedback from the assignment to understand what you need to do better.

ECON3507MockExamwithanswers.docx

ECON3507 Mock Exam

Note: This file includes very brief descriptions of what an answer would include, these are not full model answers.

Part A (50 marks)

Choose two from the following four questions:

A1. (25 marks)

A) Consider the impact of the following scenarios on the exchange rate between two countries, Country X and Country Y. Explain your reasoning for each. (15 marks)

Country X announces significant technological advancements that boost its productivity.

Country Y experiences large-scale political unrest.

There's an expectation of higher future inflation in Country X compared to Country Y.

Answer: Analyze how technological advancements in Country X could strengthen its currency by attracting investment and boosting productivity, while political unrest in Country Y might weaken its currency due to increased risk. The expectation of higher inflation in Country X could depreciate its currency value against Country Y, assuming other factors remain constant.

B) Given that both Country X and Country Y have implemented quantitative easing but Country X's economy is showing signs of recovery while Country Y's economy is still stagnant, discuss the potential long-term effects on their respective currencies. (10 marks)

Answer: For the quantitative easing scenario, explain that Country X's recovering economy might see its currency appreciate due to increased investor confidence, whereas Country Y's stagnant economy could lead to a depreciated currency value.

A2. (25 marks)

A) Assess the implications of a central bank's decision to significantly increase its purchases of government bonds. (15 marks)

How does this action affect the money supply?

What are the potential impacts on inflation and unemployment?

Answer: Discuss the effect of a central bank's increased purchases of government bonds on the money supply, which typically expands as a result. This action can lower interest rates, potentially stimulating economic activity but also raising inflation risks.

B) The Stability and Growth Pact within the European Union sets out fiscal rules for member states, including a government budget deficit limit of 3% of GDP. Discuss the rationale behind this requirement and its importance for the economic stability of the eurozone. (10 marks)

Answer: Explain the Stability and Growth Pact's deficit limit as a means to ensure fiscal discipline among EU member states, crucial for the eurozone's economic stability. A good answer will be clear how government deficits could contribute to inflation.

A3. (25 marks)

A) Discuss the implications of negative interest rate policies adopted by some central banks. How do such policies aim to stimulate economic growth, and what are the potential risks associated with them? (10 marks)

Answer: Negative interest rate policies aim to encourage lending and investment by making it costly to hold excess reserves, but risks include eroding bank profitability and the potential for asset bubbles.

B) In the aftermath of a global financial shock, central banks often engage in unconventional monetary policy measures such as quantitative easing (QE). Explain the rationale behind QE and its intended effects on financial markets and the economy. Additionally, discuss the possible long-term consequences of sustained QE programs. (15 marks)

Answer: Quantitative easing (QE) aims to lower interest rates and increase money supply, supporting asset prices and stimulating investment, but long-term consequences may include inflated asset prices and distorted financial markets.

A4. (25 marks)

A) Discuss the potential consequences of a country deciding to abandon its pegged exchange rate system in favor of a floating rate system. (10 marks)

Consider the short-term and long-term effects on inflation, interest rates, and foreign investment.

Answer: Shifting from a pegged to a floating exchange rate system can lead to initial volatility but potentially more economic flexibility in the long term. It may affect inflation and interest rates depending on the economy's openness, and foreign investment might initially retract due to increased uncertainty.

B) Explain how a sudden increase in investor confidence in a country's economy can lead to an appreciation of its currency. Assess the possible impacts of such currency appreciation on the country's export competitiveness and balance of payments. (15 marks)

Answer: Increased investor confidence can strengthen a currency, potentially harming export competitiveness but improving the balance of payments if it reflects underlying economic strengths.

Part B (50 marks)

ANSWER THIS ONE QUESTION ONLY

B1. Focusing on the effects of financial market volatility and geopolitical uncertainties on the business cycle, analyze how these external pressures have led to economic fluctuations in selected countries. Investigate how central banks have responded to such challenges, specifically in terms of maintaining financial stability and supporting economic growth.

Requirements:

For a country of your choice identify instances of financial market volatility (e.g., stock market crashes, bond yield spikes) or geopolitical events (e.g., trade wars, political instability) and their immediate impacts on the economy.

Describe the policy tools and measures employed by central banks to counteract these disturbances, including unconventional monetary policies if applicable.

Assess the effectiveness of these central bank interventions in terms of restoring investor confidence, ensuring liquidity in the financial system, and promoting sustainable economic recovery. Use relevant economic data to support your analysis.

Answer: Choose a country and discuss instances of financial market volatility or geopolitical uncertainties, like a stock market crash or political unrest. Describe central bank interventions, such as rate cuts or liquidity provision, and evaluate their effectiveness in terms of restoring confidence, ensuring liquidity, and supporting economic recovery, supported by relevant economic data.

Good answers will include data and evidence, and a clear understanding of how central bank actions can affect key variables, and how this fits with the overall mission of the central bank.

L15ECON3507.pptx

Understanding Business Cycle Fluctuations

Chapter 22

Learning Objectives

Discuss the sources of fluctuations in output and inflation.

Use AS/AD tools to analyze changes in output and inflation.

22-2

Introduction

While there is no apparent relationship between the level of inflation and recessions, it does appear that the inflation rate:

Falls when the economy is contracting.

Rises when it is expanding.

At least that is what happens most of the time.

There appears to be a connection between growth and changes in inflation.

22-3

Introduction

22-4

4

Sources of Fluctuations in Output and Inflation

Remember that long-run equilibrium means:

Y = YP output = potential output.

 = T inflation = target inflation.

 = e inflation = expected inflation.

Short-run equilibrium is:

The point where the dynamic aggregate demand curve (AD) intersects the short-run aggregate supply (SRAS) curve.

22-5

5

Sources of Fluctuations in Output and Inflation

Immediately after either the SRAS curve or AD curve shift, the economy will move away from its long-run equilibrium.

Understanding short-run fluctuations in output and inflation requires that we study shifts in AD and SRAS.

22-6

6

Sources of Fluctuations in Output and Inflation

Economists define shocks as something unexpected

A shock shifts the AD or SRAS curve.

A supply shock affects costs of production

An oil price increase.

A demand shock affects consumption expenditure

Change in consumer confidence

22-7

A Decline in the Central Bank’s Inflation Target

A fall in T shifts the monetary policy reaction curve to the left.

The decrease in the inflation target raises the real interest rate policymakers set at each level of inflation.

This reduces aggregate expenditure shifting the AD curve to the left as well.

The economy moves to a new short-run equilibrium.

22-8

A Decline in the Central Bank’s Inflation Target

22-9

A Decline in the Central Bank’s Inflation Target

At the new short-run equilibrium point, inflation and current output are lower than they were prior to the monetary policy tightening.

The dynamic aggregate demand curve shifts left, moving the economy along the SRAS

Current inflation is less than expected inflation

Expected inflation falls, shifting the SRAS right

The economy will move along the new dynamic aggregate demand curve to the new long-run equilibrium where inflation equals the central bank’s (new) target, and output equals potential output.

22-10

A Decline in the Central Bank’s Inflation Target

22-11

An Increase in Government Purchases

An increase in G shifts the AD curve to the right.

The economy moves from the original short-run equilibrium point 0 to a new short-run equilibrium point 1.

The immediate impact is to raise both current output and inflation.

22-12

An Increase in Government Purchases

Because current inflation exceeds expected inflation, this can’t be the long-run effect.

Expected inflation rises, shifting the SRAS curve to the left.

As the economy travels along aggregate demand, current inflation rises and current output falls until the point at which the dynamic aggregate demand curve crosses the LRAS curve

22-13

An Increase in Government Purchases

Inflation is higher at the new equilibrium point than it at the original.

This is above the policymakers’ original inflation target, T.

Unless monetary policy adjusts, when the dynamic aggregate demand curve shifts to the right, inflation will rise.

22-14

An Increase in Government Purchases

22-15

An Increase in Government Purchases

As long as monetary policymakers remain committed to their original inflation target, they need to do something to get the economy back to the point where it began.

In this case, tighter monetary policy shifts the AD curve to the left.

This brings the economy back to the long-run equilibrium where output equals potential output and inflation equals the central bank’s target.

Without a change in target inflation, an increase in government purchases causes a temporary increase in both output and inflation.

22-16

A Decline in Aggregate Expenditure

A decline in aggregate expenditure has the opposite effect of an increase in government spending.

The AD curve shifts to the left, driving inflation and output down.

In the absence of any monetary policy response, as lower current inflation drives inflation expectations down, the SRAS curve shifts to the right

22-17

A Decline in Aggregate Expenditure

The shift in the SRAS curve drives inflation down future and current output begins to rise toward potential.

If policymakers do not react, inflation and output will return to their original long-run levels.

22-18

Summary of Impact of Increase in Dynamic Aggregate Demand on Output and Inflation

22-19

19

Shifts in Short-Run Aggregate Supply

Changes in production costs shift the SRAS curve.

A negative supply shock that increases production costs (increase in the price of oil) will shift the SRAS curve to the left, reducing the amount supplied at every level of inflation

Higher inflation and lower growth

22-20

20

Shifts in Short-Run Aggregate Supply

The short-run equilibrium moves to where the new SRAS curve meets AD.

This creates a condition referred to as stagflation.

Economic stagnation coupled with increased inflation.

Expected inflation rises as well and because current inflation is below this level, the SRAS curve shifts back to the right

22-21

Shifts in Short-Run Aggregate Supply

Inflation continues to fall and output continues to rise until current inflation and expected inflation return to the central bank’s inflation target, and output equals potential output.

Inflation is at its highest and output at its lowest immediately following a negative shock to SRAS

Over time, self-correcting forces will unwind the shock, restoring long-run equilibrium

22-22

Shifts in Short-Run Aggregate Supply

22-23

Shifts in Short-Run Aggregate Supply

As with an increase in government purchases, a supply shock has no effect on the economy’s long-run equilibrium point.

A supply shock causes inflation to rise temporarily and then fall.

This happens at the same time that current output falls temporarily and then rises.

In the long run, the economy returns to the point where output equals potential output and inflation equals the central bank’s target.

22-24

Shifts in Short-Run Aggregate Supply

22-25

25

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ECON3507MockExam.docx