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I) The midterm
A voluntary take-home midterm will be available next week (11/17-23). Email me if you would like to take it and I will email back an exam. You have 80 minutes to complete the exam from the start time you designate. The grade distribution of midterm exams will equal that of final exams, so it will not influence by much your expected grade (although it may reduce the uncertainty). II) Past midterm and final exam questions A real mideterm has about 80 points worth of questions, a final exam has about 160 points worth of questions. This document is a compilation of questions from past exams, and is much longer than any single exam. Plausible midterm questions are marked with a *. Many of the questions were relevant in a given year; thus, the year of the exam is sometimes included in [brackets]. Short Answer: True, False, or Uncertain, and Why? The grade you receive depends solely on the quality of your explanation. If you are not sure of what the question assumes, simply state your own assumptions clearly, and answer based on these assumptions. * 1. [10] The US unemployment rate would decline rapidly if unemployment insurance were cut. 2. [10] The rate of growth of M1 and M2 have both been fairly rapid recently (Assume this sentence is true.) Thus, we can expect that the inflation rate will soon increase rapidly. [1991] 3. [10] In the late seventies the US had both high inflation and relatively high unemployment. Thus, the Phillips' curve theory is wrong, since it predicts that inflation and unemployment are negatively related. 4. [10] Recently Canada has informally maintained a fixed exchange rate with the US. (This sentence is true.) As long as they target exchange rates, monetary policy will not be effective in Canada. (You may want to refer to Canadian and US dollars as C$'s and US$'s in your answer.) 5. [10] If the Japanese would lower their interest rates to expand their aggregate demand, then Japanese purchases of US goods would increase. [Hint: Consider the exchange rate.] 6. [10] "Why is our money ever less valuable? Perhaps it is simply that we have inflation because we expect inflation, and we expect inflation because we've had it." (Robert M. Solow, Technology Review, Dec/Jan 1979: 31) 7. [10] The current U.S. Federal Government Budget Deficit (BD) is not a problem in the short run (i.e., this year). [1992] 8. [10] Fiscal policy is less effective in France than in the United States. [Hint: Consider differences both in the open-economy multiplier and the exchange rate regime.] 9. [10] Low-wage countries such Greece and Portugal will gain more from the creation on a common market than will high-wage countries such as Germany and Denmark. [1993] * . [10] True unemployment is above measured unemployment. * 11. [10] We should not worry much about inflation. * 12. [10] The multiplier is higher when marginal tax rates, marginal savings rates, and marginal propensity to import are all high. * 13. [10] Budget deficits in a recession are a good thing. * 14. [10] For each dollar of revenue lost to the government, capital gains tax cuts are less effective at spurring investment than are increases in the investment tax credit. * 15. [10] The federal government should increase spending on education. * 16. [10] Unions are responsible for a significant fraction of U.S. unemployment. [1994] 17. [10] Free trade hurts American workers, but helps workers in low-wage nations. 18. [10] It is good for the nation when monetary policy accommodates fiscal policy. * 19. [10] Frictional unemployment represents people rationally choosing to search for a job. Thus, no government policy is called for to address it. * 20. [10] European unemployment rates and unionization rates are both above U.S. levels, proving unions cause unemployment. [1994] 21. [10] In class we assumed money demand depended on output and interest rates (L = kY - hi). In the IS-LM framework, when the demand for money (k) increases at any given level of output, output and interest rates will rise. 22. [10] A balanced budget rule (so long as it corrected for cyclical factors) would be a good thing. 23. [10] Increasing consumption increases output. (Hint: Is this a trick question?) 24. [10] In an open economy, monetary policy is less effective than in a closed economy. * 25. [10] No policy can cost-effectively reduce the rate of long-term unemployment. 26. [10] Because the stock market falls when output and employment rise, the market is not a good predictor of future output growth. 27. Japan will grow faster than Russia next year. [1995] * 28. Japan will grow faster than Russia over the next 15 years. [1995] 29. Russian inflation will decline next year. [1995] 30. The creation of the EMU will reduce Italian long-term interest rates. [1996] 31. The process of qualifying for the EMU has reduced French economic growth. [1996] [10] "A Booming Economy Made it All Much Easier: For the Shrinking Deficit, Thank the Economy." [New York Times, 1997] [10] The recent actions of the Labour government concerning the Central Bank should lower expected inflation in the United Kingdom. [1997] [10] The recent appreciation of the U.S. dollar is bad for Argentine. [1997] [10] Ireland should join the European Monetary Union. [Hints: Ireland's economy is closely tied to Europe but most closely to the United Kingdom; Irish inflation has historically been above the EC average; the Irish economy has been growing rapidly for several years and is likely approaching the output level associated with the non-accelerating inflation rate of unemployment; and the Irish currency has been near the top of its permissible band of fluctuation against other European countries.] [1997] [10] "Investors give East Europe a miss: Problems with legal system, taxes, crime and corruption deter foreign funds." [Financial Times, 1997] [10] The EMU should include Italy. [1997] [10] The multiplier is higher when marginal tax rates, marginal savings rates, the marginal propensity to import are all low and the investment accelerator is high. * [10] The government should subsidize private savings. * [10] The capital gains tax should cut, but only if it is reformed. * [10] The government should subsidize student loans for college. Longer answers 32. [26] In 1990 the strange and wonderful nation of Bezerkly could best be modelled with the following one-sector model of a closed economy: Y = C + I + G C = C0 + c Y = 50 + .8 Y I = I0 + fY = 50 + .1 Y G = G0 = 100 This model differs from the standard textbook model because when sales increase by $1, Bezerk investors see that they need new factories, and investment increases by $f, where the parameter f is between zero and one. a) [8] Derive the government spending multiplier in this model either symbolically or numerically. Compare it to multiplier when f = 0. (Recall that if f= 0, then the multiplier in this model dY/dG = 1/(1-b) = 1/(1-.8) = 5. To help you with your arithmetic, Y = 2000 in the example above.) b) [8] Explain in words the intuition behind the comparison of the two multipliers. c) [10] What happens to output if G0 falls to 90? What happens to national savings? Show national savings (S - gov't deficit)=I after the shock. 33. [20] As time passed the Telegraph was invented and brought news from the outside world about the wonderful concept of money. Soon thereafter money is introduced into the Bezerker economy, undoubtedly by some non-politically correct dean or economist. In addition, repetitive drumming in by microeconomics, finance, accounting and macroeconomics professors convinces managers to pay attention to interest rates when choosing how much to invest. Now the nation is best modelled with the following IS-LM model of a closed economy: C = C0 + cY = 50 + .8 Y I = I0 + fY - bi = 50 + .1 Y - i G = G0 = 100 L = kY - hi = Y - 10i Money demand M/P = 1800 Money supply A. Derive the formulae for the IS curve and the LM curves. (Don't use numbers for this question.) B. What are the equilibrium levels of income and interest rate? (Do use numbers for this question.) 34. [30] While in class we focussed on fixed vs. flexible exchange rates, many nations have intermediate cases. For example, some nations have band, where rates are fixed plus or minus some percent. For example, a nation may fix its rates at 10 pesos per dollar plus or minus 4 percent, thus fixing between 9.6 and 10.4 pesos per dollar. In other cases the fixed rate has a crawl built into it: We fix at 10 pesos to the dollar, depreciating 1 percent per month. Other nations combine the two: a band each month, with built-in depreciation over time. What are the advantages and disadvantages of these hybrid systems compared to pure fixed rates? [30] After evaluating all other relevant arguments for and against adoption of a fixed currency, policymakers in the small open economy of Haasland are still undecided. The costs seem to exactly equal the benefits. The last piece of information they are to consider is that Haasland has historically been subject to more shocks of consumer and investor confidence than supply or price shocks. Given this fact and the desire of Haasland policymakers to stabilize output, what exchange rate policy would you recommend? [Hint: Make reference to IS-LM diagrams in which you show the effect on output and interest rates of a negative shock to the IS curve (consumer or investor confidence) and a negative shock to the LM curve (supply or price shock) under both fixed and floating exchange rates.] [30] In 1984, the small open economy of New Zealand had a policy of maintaining a fixed exchange rate. Suddenly, due to a political crisis, the risk premium for investment in New Zealand increased dramatically. Policymakers were left with two options: 1) raise interest rates or 2) devalue the currency. Recommend a response based on an analysis of the impact of these policies on output, interest rates and inflation, making reference to an IS-LM diagram. [Hint: Would it matter where output was relative to Y*, the output level associated with the non-accelerating inflation level of unemployment?] David I. Levine Associate professor Haas School of Business ph: 510/642-1697 University of California fax: 510/643-1420 Berkeley CA 94720-1900 email: levine@haas.berkeley.edu http://web.haas.berkeley.edu/www/levine/
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