Macroeconomics: Key Concepts and Applications

Posted on Mar 6, 2025 in Economy

1. Small Open Economy with Perfect Capital Mobility

Consider the case of a small open economy with perfect capital mobility. Suppose that the government raises public expenditure and taxation by the same amount. Starting from a long-run equilibrium, this policy will have the following long-run impact:

c. A rise in the real exchange rate, a drop in net exports, and no change in GDP.
d. None of the above answers is correct.

2. Negative Demand Shock in a Closed Economy

Consider a country that is hit by a negative demand shock that reduces output below its natural level. Use the AD/AS framework for a closed economy to analyze the policy options.

b. An expansionary monetary policy can shift the AD back to its original position and will stimulate private investments.

3. Tariff Imposition in a Small Open Economy

Consider a small open economy with perfect capital mobility and a flexible exchange rate. The country decides to impose a tariff on its imports. Use the Mundell-Fleming model to analyze the short-run implications of this policy, assuming that the economy is initially in a short-run equilibrium with balanced trade. The new equilibrium is characterized by:

a. The same level of income and net exports as before the introduction of the tariffs and a higher nominal exchange rate.

4. Monetary Union and Labor Productivity

Consider two countries, say A and B, that are part of a monetary union. Labor productivity is constant in both countries. In country A, nominal wages and the price level grow at an annual rate of 3%, while nominal wages and the price level in country B grow at an annual rate of 5%.

b. In country B, the wage costs per unit of output – the so-called unit labor costs – are rising faster than in country A, resulting in a 2% appreciation of its real exchange rate.

5. Short-Run Aggregate Supply Curve

There are several theoretical explanations for the positive (and finite) slope of the short-run aggregate supply curve. According to the sticky wage explanation:

c. The short-run rigidity of nominal wages generates counter-cyclical movements in real wages and pro-cyclical movements in employment.

6. Short-Run Philips Curve

Suppose that the short-run Philips curve of a country can be written as π_t = π_t^e − 0.5(u_t − 0.05), with π_t^e = π_t−1, where π_t and π_t^e denote, respectively, the realized and the expected inflation rate in t. Consider the following statements.

i. According to the above specification, the non-accelerating inflation rate of unemployment (NAIRU) is equal to 5%.
ii. If the government wants to reduce the inflation rate by 3 percentage points, it can choose between accepting an inflation rate of 11% during one year or a 7% unemployment rate during three years.
iii. The sacrifice ratio is equal to 2.
c. Only statements i and iii are correct.

7. Small Open Economy with Fixed Exchange Rate

Consider the case of a small open economy with perfect capital mobility called Home with a fixed exchange rate regime in which:

C(Y −T ̄) = c₀ + c₁(Y − T ̄)

I(r^∗) = i₀ − i₁r^∗

G = G ̄

XN(e) = m₁Y^∗− m₂Y − m₃(e − e ̄)

where G ̄ and T ̄ denote exogenous fiscal policy, r^∗ denotes the international real interest rate, e ̄ is the fixed exchange rate, while Y and Y^∗ denote, respectively, domestic GDP and GDP of the rest of the world. Finally, (c₀, c₁, m₁, m₂, m₃) are strictly positive parameters with m₂ > m₁. Choose the correct statement.

b. The value of the fiscal multiplier is given by 1/[1 − c₁ + m₂].

8. Formation of a Monetary Union

Suppose a group of countries decides to form a monetary union. Choose the correct statement.

c. The member states may be subject to the risk of self-fulfilling liquidity crises if the Central Bank cannot act as a lender of last resort.

9. Taylor Rule

Suppose the Central Bank of a country follows this Taylor rule:

i_t = r^∗ + π_t + γ(π_t − π^∗) + ρ(y_t − y_n)

where r^∗ is the neutral interest rate, π^∗ the inflation target and (y_n − y_t) denotes the output gap. Choose the correct statement:

c. According to the above rule, the Central Bank will aim for a real interest of r^∗ if the inflation rate is equal to its target and the output gap is zero.

10. Debt Dynamics and Sustainability

Consider the following statements about debt dynamics and the sustainability of public debt.

The stabilization of the debt-to-GDP ratio requires a primary budget surplus whenever the interest rate is larger than the growth rate of GDP.