Macroeconomics

Question 1

GDP

Answer 1

Production: value of final goods and services sold to consumers, sum of value added
Income: wages for employees + profit for owner
Expenditure: Y = C + I + G

Question 2

Inflation

Answer 2

Sustained rise in price level

• GDP deflator
• Consumer price index CPI

Question 3

Goods market

Answer 3

In equilibrium: Y = Z
Z = C + I + G
Z = c0 + c1 * (Y -T) + I + G

Multiplier: increase of income and production higher than initial increase of consumption –> initial increase of demand triggers increase of production, leading to increase of income, increase of demand…

Question 4

Financial market

Answer 4

Demand for money: Md = PY * L(i)
–> depends negatively on interest rate

Money supply: Ms = M

Equilibrium: Md = Ms
PY * L(i) = M
–> Interest rate in equilibrium must be such that money demand and supply are the same

Question 5

Monetary policy of ECB

Answer 5

Minimum reserve requirements for banks: the higher, the lower is money supply, the higher interest rate

Main refinancing operations rate: interest rate at which commercial banks borrow from ECB –> the higher, the lower Ms, the higher interest rate

Open market operations:

• Expansionary: ECB buys bonds, gives money to market (Ms increases), interest rate decreases
• Contractionary: ECB sells bonds, withdraws money (Ms decreases), interest rate increases

Question 6

Money multiplier

Answer 6

Demand and supply of money ≠ demand and supply of central bank money (only if there were no commercial banks)
Money in circulation is higher than central bank money supply –> lending activities of commercial banks

Total money supply = supply of central bank money * money multiplier

Question 7

Liquidity trap

Answer 7

CB chooses interest rate by choosing appropriate money supply

• -> increase interest by decreasing Ms
• -> decrease interest by increasing Ms

If interest rate is zero: CB can’t decrease more –> economy is in a liquidity trap
Zero lower bound

Question 8

Goods market and IS relation

Answer 8

Investments I now positively depends on Income Y and negatively on interest rate I

Increase i, decrease I, decrease Z, decrease Y
Negative relation between i and Y represented on IS curve

IS: all points on curve represent combi of i and Y corresponding to equilibrium in goods market

Question 9

Fiscal policy

Answer 9

Fiscal contraction: increase in taxes decreases demand –> IS shifts left, output decreases (same interest)
Fiscal expansion: increase in G increases demand –> IS shifts right, output increases (same interest)

Question 10

Financial market and LM relation

Answer 10

Horizontal line at value of interest rate independent from output
All points on LM represent equilibrium in financial market (CB adjusts i to achieve equilibrium)

Question 11

IS-LM relations

Answer 11

Where IS and LM intersect –> overall equilibrium in goods and financial market

Question 12

Fiscal and Monetary Policy

Answer 12

Fiscal: impact on IS curve
Contraction: increase T, decrease G –> IS shifts left, decrease of Y (at same LM interest)
Expansion: decrease T, increase G –> IS shifts right, increase of Y (at same LM interest)

Monetary: impact on LM curve
Contraction: increase i –> LM shifts upwards, lower output (at same IS)
Expansion: decrease i, –> LM shifts down, higher output (at same IS)

–> often a Monterey-fiscal policy mix is used to reach even higher levels of output or avoid too much output decrease

Question 13

Wage setting, Price setting

Answer 13

Wage setting: W/P = F(u, z)
–> function negatively impacted by unemployment u and positively by unemployment benefits z

Price setting: W/P = 1 / (1+m)

Equilibrium: F(u,z) = 1 / (1+m)
–> Intersection at natural rate of unemployment: medium run equilibrium unemployment rate

Question 14

Philips curve

Answer 14

Negative relationship: high unemployment associated with low inflation and vice versa

Expectations-augmented Philips curve: high unemployment associated with negative/decreasing changes in inflation rate

Natural rate of unemployment –> inflation is stable (no change in inflation rate)
Philips curve: change in inflation rate depends on difference between actual and natural rate
- actual < natural –> inflation rate increases
- actual > natural –> inflation rate decreases

Question 15

PC relation

Answer 15

Positive relation between output and change in inflation rate
Potential output where change in inflation rate is zero

Y above potential –> inflation rate increases
Y below potential –> inflation rate decreases

Question 16

IS-LM-PC Model

Answer 16

combines equilibrium in goods market (IS) with equilibrium in financial market (LM) and the Philips curve relation (PC)

–> use fiscal and monetary policy to to bring output to potential and keep inflation rate stable

Question 17

Debt spirals

Answer 17

Lower output (can’t be increased to potential due to zero lower bound) leads to deflation, more deflation leads to higher real interest rate (r = i - π) which leads to lower output, leading to more deflation….

Question 18

Real exchange rate

Answer 18

Decision to buy domestic or foreign goods depends on the relative price –> real exchange rate

e = nominal exchange rate * domestic price level / foreign price level
–> number of goods you get in exchange for one domestic

Question 19

Appreciation vs. Depreciation

Answer 19

Nominal exchange rate

• Appreciation of domestic currency: increase price of domestic currency in terms of foreign currency –> can buy more foreign goods with 1€
• Depreciation of domestic currency: decrease price of domestic in terms of foreign –> can buy less foreign goods with 1€

Real exchange rate

• Appreciation: increase in real exchange rate –> can buy more foreign goods with same amount of domestic goods
• Depreciation: decrease in real exchange rate -> can buy less foreign goods with same amount of domestic goods

Question 20

Interest parity condition

Answer 20

Both bonds (e.g.: Austrian and UK) lead to the same expected return on investment --> both bonds are held
In equilibrium, interest parity condition must hold true

• If European bonds preferred: British sell UK bonds, exchange pound for € and buy European bonds –> € demand increases, € appreciates –> move back to interest parity condition
• If UK bonds preferred: Europeans buy British bonds, therefore exchange € for pound –> € demand decreases, € depreciates –> move back to interest parity condition

–> investment decision depends on both interest rates and expected depreciation of foreign currency

Question 21

IS in open economy

Answer 21

Imports (domestic demand for foreign goods) depends on Income Y and real exchange rate

• the higher Y, the higher imports
• the higher e, the higher imports

Export (foreign demand for domestic goods) depends on foreign Income Y* and real exchange rate

• the higher Y*, the higher exports
• the higher e, the lower exports (foreign currency depreciates)

Question 22

Net exports

Answer 22

Exports - Imports

With increasing output, imports increase while exports are unaffected –> decreasing net exports

• Trade balance: NX = 0
• Trade surplus: NX > 0
• Trade deficit: NX < 0

Question 23

Equilibrium output

Answer 23

Where ZZ-line (DD - Imports + Exports) and 45° Line (Demand equals output) intersect