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(ECON514)2008_f_econ514_final.pdf
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Economics 514
Macroeconomic Analysis
Final Exam
December 16, 2008


1.
The dynamics of the debt of the government are written as where Gt is government spending and TAXt is taxes net of transfer payments. Output starts at a level Y0 = 1 and grows at a rate of 10% per year (i.e.tYgY., g=.1). Assume that at time 0, the outstanding debt is 100% of GDP (i.e.=). Define government spending as a fraction of GDP as. The government projects that it will spend 10% of GDP forever (i.e. gy = .1). The government would like to set taxes at a constant fraction of GDP,tyY. Assume that there are no distortionary effects so ty has no impact on output. Calculate the level of ty the government will have to set to satisfy the intertemporal budget constraint if the real interest rate is 21% (i.e. r = .21).









2.
The demand for real balances is given by the Baumol-Tobin theory so that we can write





The growth rate of output is always 5%, gY = .05. The real interest rate is always 10%, r=.1.
At time 0, Y0 = M0 = 100. The growth rate of money is set at a permanent level, gM .
Solve for the price level when gM = .1 and when gM= 0. Explain briefly, in words,
why the answer for gM = .1 is larger than for gM= 0.


3.
Consider an economy in which expenditure is a negative function of the real interest rate:





Where dt = 1. The central bank sets the real interest rate as an increasing function of the inflation rate
.

Workers sign dollar wage contracts to keep their real wages fixed at an equilibrium level. If prices rise faster than wages, then firms will increase output above potential output,



Assume rational expectations, so
. Assume that potential output follows a random walk so
where


a.
Assume that b = 1. Write the model consistent expectations of output and inflation at time t-1 as a function of.












b.
Assume that b=1. Write actual output and inflation as a function of andt.



c.
Solve for the level of b that would always set output equal to potential output,. What would inflation be at this level of b?








4.
Below is a picture of the Keynesian AS-AD model. Draw what happens to the equilibrium if there was a shift outward in potential output.



In the below graph, draw an AD curve that would insure that output was always equal to potential output even after potential output changes.

What kind of monetary policy might generate such an AD curve?

yt

t

AD

AS

yP

yt

t

AD

AS

yP

5.
The government has two goals for monetary policy: 1) stable prices; and 2) high output. The preferences of the government are to maximize





Suppose that output is given by
. Normalize potential output
= 0. Also suppose that, once wage contracts are signed, the government can set inflation at whatever they like through the us