ME2016Q3 (Lars) Flashcards

Question

Why is the LM curve upward sloping?

Answer 1

Equilibrium in financial markets implies that, for a given real money supply, an increase in the level of income, which increases the demand for money, leads to an increase in the interest rate. This relation is represented by the upward-sloping LM curve.

Answer 2

* Consumers are likely to take some time to adjust their consumption following a change in disposable income.   * Firms are likely to take some time to adjust investment spending following a change in their sales.   * Firms are likely to take some time to adjust investment spending following a change in the interest rate.   * Firms are likely to take some time to adjust production following a change in their sales.  

Answer 3

A liquidity trap is when the interest rate is equal to zero ## Footnote The central bank can increase liquidity—that is, increase the money supply. But this liquidity falls into a trap: The additional money is willingly held by people at an unchanged interest rate, namely zero. If, at this zero interest rate, the demand for goods is still too low, then there is nothing further conventional monetary policy can do to increase output.

Answer 4

Fiscal policy also has its limits since a government cannot run with large budget deficits for a longer period. At some point lenders will start misbelieving in the country's ability to pay back its loans and will thus start increase the interest rate. Thus, countries with too large debt are in risk of running into a spiral where the debt is constantly increasing due to rents.

Answer 5

* Goods market: consumers can choose between domestic or foreign products but there are still quotas and tariffs * Financial markets: the ability to trade foreign assets. Many countries still have capital control of both the domestic population’s investments overseas and foreign investors in their own country * Factor markets: possibility of producing overseas and workers can move between borders and work in different locations

Answer 6

This is due to import of intermediate goods to produce the goods exported. Example: Export: 100, Import: 90, NX = 10 C = 10, I = 10, G = 10 Y = 40 \< exports = 100

Answer 7

The price of the domestic currency in terms of foreign currency (it can also be the other way around. The foreign currency in terms of the domestic currency) 1 DKK = 0.13 Euro (1 Euro = DKK 7.45)

Answer 8

The price of domestic goods in terms of foreign goods, denoted by ∈. The real exchange rate determines your choice between consuming domestic or foreign goods. ∈ = EP/(P^\* (the foreign price)) **When increasing, domestic goods are becoming more expensive relative to foreign goods and NX decrease (Marshall-Lerner)** Selling bike at P = 4000 DKK ⇒ exchanging into euros and get 520 euros ⇒ go to Germany where the price of a new bike is 260 euros (P^\*). Thus EP/P^\* = 520/260=2. or (4000x0.13)/260 = 2.

Answer 9

The balance of payment is a record of all payments or monetary transactions between a particular country and the rest of the world during a specific time period. It is taking both trade flows and financial flows into account.

Answer 10

**Current account balance:** * Import and export * Net income: Income of financial assets for domestic and population foreign population (income received – income paid; salaries, income from financial investments, dividends etc.) * Net transfers received (negative for developed countries; it is donor money for emerging markets) aids, donations, workers’ remittances **The capital account:** * Value of assets (foreigners lending money to the country) * Buying assets overseas * Net capital flows/capital account balance _Statistical discrepancy_ The current account and the capital account are mirrors of each other and should equal. However, because of statistical difficulties Statistical discrepancy occurs (the difference between current account balance and the capital account balance).

Answer 11

Uncovered interest parity, or interest parity for short, is an arbitrage condition stating that the expected rates of return in terms of domestic currency on domestic bonds and foreign bonds must be equal. **i = i^* - ((E^e-E)/E)** If E^e \< E then ((E^e-E)/E) will be negative (\<0) and i will have to by larger than i^* Or: **E = (1+i)/(1+i\*) \* E^e** * If domestic interest rate, i increases, E increase * If foreign interest rate, i\* increases, E decreases * If E^e increases, E increases

Answer 12

NX = net exports which is exports - imports NX = X(Y^*, ∈) - IM(Y, ∈) + - + + ∈ is negative for X (higher real exchange rate, less export because the domestic goods are more expensive for foreigners) IM/∈ ==\> converting the imported goods into the values of those goods in terms of domestic prices and currency NX decreases as Y increase DD(domestic demand), AA(domestic demand for domestic goods), ZZ(domestic demand for domestic goods + exports)

Answer 13

Y = C + I + G + NX Y = C₀+C₁(Y-T) + I(Y, **r**) + G + X((Y^*, ∈)1) - IM 1/∈((Y, ∈) r instead of i ==\> REAL interest rate **Y = C₀+C₁(Y-T) + I(Y, i) + G + NX(Y, Y\*, ∈**) An increase in the interest rate will 1) Decrease Invesment 2) Decrease NX through the appreciation of the currency making domestic goods more expensive (decrease in X and increase in IM)

Answer 14

The multiplier will increase if a reduction in the marginal propensity to import occurs.

Answer 15

In an open economy, an increase in domestic demand (by changing C, I or G) has a smaller effect on domestic output than in a closed economy because some of the increased demand will be used on foreign goods. Thus, the increased domestic demand will lead to an increased trade deficit. Thus an expansionary fiscal policy will decrease NX.

Answer 16

Increase in foreign demand leads to an improved trade balance because exports increase more than the increase in import as a result of the increased domestic income. Unfortunately we do not control Y^*.

Answer 17

The Marshall Lerner condition says that when: ## Footnote E decreases==\> ∈ decreases (EP/P\*) ⇒ increase in exports + decrease in import (over time; J-curve - the time-frame is ignored with the Marshall-Lerner condition) Z= C + I + G + X (Y\*, ∈) - IM (Y, ∈) ∙1/∈ Quantity effects: X up, IM down (Z increases) Price effect: (1/∈) increases (Z decreases)

Answer 18

**First** * Depreciation will first lead to an even bigger trade deficit. Over time it will be improved. Thus we have J-curve (typical delay time is 6-12 months but it can take years) * Prices will change first (1/∈) * Then quantities in import and export will change * Net exports and output will be improved Depreciation leads to a shift in demand, both foreign and domestic, toward domestic goods. This shift in demand leads, in turn, to both an increase in domestic output and an improvement in the trade balance.

Answer 19

* Depreciation of the currency to increase exports and improve the trade balance * Lower domestic demand by decreasing government spending (G)

Answer 20

* Imports larger than exports * Large purchases of foreign currency (to pay imports) * Value of the domestic currency goes down (nominal exchange rate): depreciation * Thus, exports will increase + imports decrease è demand increase è output increase è multiplier effect. * Increase in output and improvements of the trade balance

Answer 21

Closed economy: i increase==\>I decrease==\>Z decrease==\>Y decrease Open economy: i increase==\>I decrease==\>Z decrease==\>Y decrease and i increase==\>E increase==\> NX decrease ==\>Z decrease==\>Y decrease

Answer 22

G increases C increases as Y(income) increases (multiplier effect of increase in G) Interest rate increases: I decreases + second effect: E increase = appreciation ==\> i will have to decrease and thus I is ambiguous Due to appreciation NX will decrease (cheaper to import, more expensive for foreigners to buy domestic goods (export))

Answer 23

G is constant C will decrease as Y(income) decreases i increases so I decrease + i increase forcing an appreciation which will ... NX decreases due to the appreciation

Answer 24

Under fixed exchange rates, the central bank gives up monetary policy as a policy instrument. With a fixed exchange rate, the domestic interest rate must be equal to the foreign interest rate. And the money supply must adjust so as to maintain the interest rate. Fixing ⇒ Expected E = E and i= i\*

Answer 25

Fixed exchange regime because fiscal policies ALWAYS will be accomodated by monetary policy to maintain the interest rate so that i = i^*

Answer 26

**Labor supply:** total hours that workers wish to work for a given real wage rate **Labor demand:** quantity of labor (in hours) that is demanded by firms for any given real wage rate

Answer 27

The wage that would make a worker indifferent between working and being unemployed

Answer 28

* **Collective bargaining:** wages bargained by labor unions * Unions have higher bargaining power than the individual * A general rule of thumb: the more skills that are needed to do a job, the more bargaining there will be (McDonalds is take it or leave it) * **Individual bargaining power:** this depends on * Cost of replacing for the company * How hard it would be for the employee to find another job if quitting Firms derive bargaining power if it is hard to find a new job (matching frictions) * **Efficiency wages:** * Companies seeing morale and commitment as essential pay higher wages * High employee satisfaction equals higher productivity * Low unemployment equals higher wages

Answer 29

W = P^e F(u,z) W/P = F(u,z) * Proportional with P^e (assumption) * Increased u = lower nominal wages (W) * Increase in z = increase in W * Unemployment insurance (increases nominal wages at any given unemployment rate) * Minimum wages * Employment protection: the more expensive it is to lay off workers, the higher bargaining power an employee will have and thus higher nominal wages

Answer 30

**Wage-setting relation (WS):** W/P = F(u,z) * **W = P^e \* F(**z, **u**) * Wages will be higher, the lower the unemployment and the higher the exprected prices, P^e * z = other favtors such as unemployment benefits etc. **Price-setting relation (PS):** W/P = 1/1+m * **P =** (1+m) **W** * ****Firms set higher prices, the higher the cost (wages) * (1+m) is other factors that affect prices At the equilibirum we have U_n

Answer 31

In general, the actual price level may turn out to be different from the price level expected by wage setters. Therefore, the unemployment rate need not be equal to the natural rate of unemployment.

Answer 32

If u_n increases, Y_n will decrease

Answer 33

This will decrease firm's markups, m Decreasing m will shift PS up and thus u_n down and Y_n up AS curve will shift down and P will decrease and Y increase

Answer 34

An increase in the minimum wage, will increase z and thus increase wages moving the WS relation to the right. Conclusively, u_n will increase and y_n will decrease AS curve will shift up and P will increase and Y decrease

Answer 35

Cutting in unemployment benefits will decrease z and shift the WS-relation to the left. Thus, u_n will decrease and y_n will increase AS curve will shift down and P will decrease and Y increase

Answer 36

P=P^e(1+m) F(Y, z) * When Y increases, N increases, u decreases and thus P increases (positive effect) * As markup increases, P will increase (positive) * As Z increases, P will increase (positive) * P^e has a one-for-one effect on P. If prices are expected to increase, they will increase (through nominal wage increases, which increase costs and thus increases prices)

Answer 37

Y = Y(M/P, G, T) * M/P has a positive effect. Increase in M/P (real money supply) will increase Y * G has a positive effect. Increase in G, increases Y * T has a negative effect. Increase in T will decrease Y. Any variable other than the price level that shifts either the IS curve or the LM curve also shifts the aggregate demand relation.

Answer 38

Not in the short run as P won't neccesarily be equal to P^e. In the medium run prices will be adjusted and P will equal P^e and Y = Y_n P^e from the AS relation will adjust over time

Answer 39

**Short run + First stage of the medium run:** Money supply increases; The monetary expansion shifts the LM and thus AD curve to the right giving a higher Y in the short run (ISLM: from A to B + B to A’ because of the lower unemployment that leads to higher wages and higher prices – when prices increase, the real money supply M^s/P will decrease and LM will shift a bit up and output goes down), and AS-AD from A to A’) **Second stage medium run:** A’ to A” in AS-AD. Prices have already increased in the first stage. Thus, expected prices will go up and the AS-curve will shift (nominal wages increase, prices increase and then real money supply M^s/P decrease (interest rate increase, output decrease) and as a consequence unemployment will increase.

Answer 40

**Short run and first stage of medium run:** * Decreased G ==\> IS curve will shift to the left to IS’. The interest rate will decrease to get money demand up to money supply (this is all A To B partially offsetting the negative effect on output because I increase). * The AD curve will shift leftward (A to B (B is not marked) and B to A’ ==\> decrease in prices which make real money supply M^S/P increase and thus LM curve will shift down to LM’ (and output increase a bit + interest rate decrease a bit **Second stage medium run:** (always a change in expectations) * Prices are lower than the expected and thus expected prices will go down and AS-curve will shift down (AS to AS”) and we will get from A’ to A” * From A’ to A” prices decrease and the real money supply M^S/P increase even more and we will see LM’ shift to LM”.

Answer 41

**Short run:** Decrease in T will shift IS curve right to IS’ and AD right to AD’ causing increased interest rate, increased Y and increased prices **First stage medium run:** The increase in Y, lower unemployment rate and higher prices will be partially offset by a decrease in M^s/P shifting LM to LM’ and AD’ to AD’’ **Second stage medium run:** At A”: P \> P^e. Thus, in the second stage medium run price expectations will change until P = P^e and Y = Y_n. As prices increase, M^s/P will decrease and LM’ will shift up to LM” and the AS-relation (with P^e) will shift up to AS’. The new equilibrium points will be A’’’. We conclude that interest rate has increased, prices have increased and that output, Y is the same. **Composition of GDP:** C will have increased due to lower T, I will have decreased due to higher interest rate and G is the same.

Answer 42

**AD in closed economy:** P increases, M/P decreases, LM shifts leftwards, interest rate increases, money demand decreases, investment decreases, output decreases (AD is downward sloping). **AD in an open economy:** Two effects 1. P increases, M/P decreases, LM shifts leftwards, interest rate increases, money demand decreases, investment decreases, output decreases (AD is downward sloping). 2. Price level increase ==\> Real appreciation (EP/P^*) ==\> NX decreases (Marshall Lerner condition) ==\> Output decreases Effect 2 is ONLY IN FLEXIBLE EXCHANGE RATE SYSTEMS Because in fixed exchange rate regimes money supply will be increased if prices increase to keep the ratio M^s/P constant and interest rate, Investment + Output constant.

Answer 43

* G increase or T decrease ⇒ IS shift to the right (output increases, the interest and the nominal exchange rate increases (E= (1+i)/(1+i^\* ) E^e), decreasing investment and NX which partially offset the initial increase in output. * In AS-AD the AD curve shifts rightwards (output is higher for a given price level) ⇒ A to A’ A’ to C ⇒ P increases ⇒ M/P will change and shift LM curve up, interest rate increases, investment decreases and Y decreases. * Second effect (exchange rate) P increases, ∈ (EP/P\*) increase, NX decrease (Marshall-Lerner), IS left ⇒ Y decrease When working with AS-AD in open economy you are not supposed to draw IS-LM because it will get too messy due to many stages (you might have to do it in short-run only though)

Answer 44

* M/P increases ⇒ LM shift to the right ⇒ Y increase, interest rate decreases, I increases, NX increases * AD curve shifts right (from A to A’) * Output increases, unemployment decreases, nominal wages increase, p increase and y will decrease. * In IS-LM ⇒ * 1) Increase in P will decrease M/P and LM will shift left * 2) Increase in P will lead to real appreciation and decrease in NX and IS will shift leftward * In AS-AD we move from A’ to C. When working with AS-AD in open economy you are not supposed to draw IS-LM because it will get too messy due to many stages (you might have to do it in short-run only though)

Answer 45

Not possible Monetary policy cannot be used since a change of LM will change the interest rate that will lead to a change in the nominal exchange rate.

Answer 46

When doing so, the central bank will have to do monetary expansion at the same time, otherwise the interest rate will not stay constant and currency will appreciate. * Both IS (increasing interest rate and output) and LM (decreasing interest rate and increasing output) will shift right. A to A’ * From A’ to C ⇒ Prices increase, Money supply and M/P will be constant * ⇒ P increase, ∈ increase, NX decrease, IS shifts left + LM left (contractionary monetary policy to keep M/P constant and interest rate constant) and Y decrease. When working with AS-AD in open economy you are not supposed to draw IS-LM because it will get too messy due to many stages (you might have to do it in short-run only though)

Answer 47

Expectations in prices will change and the AS curve will shift. * First, as prices go down, real money supply increases: similar to an expansionary monetary policy (only for flexible exchange rate regime) * Second, as prices go down, the real exchange rate depreciates and this leads to an increase in net exports

Answer 48

What firms want to invest must be equal to what people and the government want to save **Equilibrium in a market is either stated as:** Production = demand, or Investment = savings (private + public savings) Y = C + I + G Y – T = C + I + G – T (subtracting T from both sides) Y – T – C + T – G = I (isolating I) Spri + Spub = I. **You can see the IS relation as:** i ==\> I (planned investment) ==\> Y Y ==\> S ==\> I

Answer 49

CA = S + (T - G) - I NX = S - I Current account surplus: Savings \> Investment Current account deficit: Savings \< Investment

Answer 50

Monetary expansion will decrease the interest rate and thus make it less attractive to invest in the domestic country. Thus, the demand for domestic currency will fall and the currency will have a real depreciation (EP/P\*)

Answer 51

Fiscal expansion will increase the interest rate and thus make it more attractive to invest in the domestic country. Thus, the demand for domestic currency will increase and the currency will have a real appreciation (EP/P\*)

Answer 52

1/x² ==\> rewrite as x^-2 (x^1/2)^2/3 ==\> x^1/2*2/3 ==\> x^1/3 3x^1/2 = x^2/3 ==\> 3 = x^2/3-1/2 ==\> 3 = x^1/6

Answer 53

* G increases * C increases as Y(income) increases (multiplier effect of increase in G) * Interest rate increases: I decreases + second effect: Y has increased and I will increase so I is ambiguous * Due to appreciation NX will decrease (cheaper to import, more expensive for foreigners to buy domestic goods (export)) Y = C0+C1(Y-T) + I(Y, i) + G + X((Y\*, ∈)1/E) - IM((Y, ∈)1/E) This explains ∈ ==\> E = ((1+i)/(1+i\*))\*Ee

Answer 54

* G is constant * C will decrease as Y(income) decreases * i increases so I decrease + Y decrease and will decrease I even more * NX decreases due to the appreciation (higher interest rate will make E appreciate) Y = C0+C1(Y-T) + I(Y, i) + G + X((Y\*, ∈)1/E) - IM((Y, ∈)1/E) This explains ∈ ==\> E = ((1+i)/(1+i\*))\*Ee

Answer 55

IS curve: i↑, I↓, Y↓: the IS curve is downward sloping If the sensitivity of investment to changes in the interest rate increases, it means that an increase in the interest rate will lead to a large decrease in investment, and therefore in output. The IS curve is flatter the higher this sensitivity.

Answer 56

Decrease in reserves: money supply increases, LM shifts rightwards. In order to maintain the equilibrium on the money market, the interest rate decreases. This has a positive effect on investment and output, and this positive effect is larger when investment is very sensitive to variations in the interest rate.

Answer 57

c) the exchange rate would decrease.

Answer 58

b) an increase in the marginal propensity to save

Answer 59

c) net exports equal savings minus investment

Answer 60

b) a relative high growth rate for some time

Answer 61

e) none of the above

Answer 62

Expansionary monetary policy to achieve both a lower interest rate and a decrease in the exchange rate—a depreciation.  

Answer 63

It cannot use fiscal or monetary policies to do so since E is fixed and i = i\*. Only opportunity in the short run would be to devaluate the currency but this wil be risky in case the financial market will fear an additional devaluation afterwards. A devaluation leads to a real depreciation that pushes net exports up. The aggregate demand curve shifts rightwards (output is higher for a given price level). We go from A to A’ (not in the graph). Output goes up, unemployment goes down. Workers bargain for higher nominal wages. Prices go up. Increase in prices will cause an appreciation which will decrease NX and thus partially offset the increase in Y (we move from A' to C)

Answer 64

As long as output is below the natural level of output, the price level de- creases. The decrease in the price level over time leads to a steady real depreciation (EP/P\*). This real depreciation then leads to an increase in output until output has returned to its natural level (foreign price level assumed to be constant)

Answer 65

* Give in and devalue (or exit the fixed exchange rate system) * Fight and maintain the parity at cost of a very high interest rate and a potential recession (risk of exhausting all the foreign reserves and being obliged to devalue at some point) * i = i\* - ((E^e-E)/E)

Answer 66

* When a group of countries is highly integrated and forms an optimal currency area. (You can think of a common currency for a group of countries as an extreme form of fixed exchange rates among this group of countries.) For countries to form an optimal currency area, they must either face largely similar shocks, or there must be high labor mobility across these countries.   * When a central bank cannot be trusted to follow a responsible monetary policy under flexible exchange rates. In this case, a strong form of fixed exchange rates, such as dollarization or a currency board, provides a way of tying the hands of the central bank.  

Answer 67

Malthusian trap: using all output growth on population growth and thus no growth in output per capita

Answer 68

K ==\> Y (Income/output) ==\> Savings/Investment ==\> K (back to the beginning and going round in circles)

Answer 69

In chapter 11 we assume that: (to clearly see capital accumulation) * N is constant (and thus population size, unemployment rate and participation rate also constant) è thus output per worker, output per capita and output itself all move proportionately * No technological progress * savings are only private savings. S = I. We assume that private savings, S is proportional to income so I = sY

Answer 70

**Steady state:** The state in which output per worker and capital per worker are no longer changing is called the steady state of the economy. k_t+1- k_t = f(k_t ) -δk_t _==> Where sf(k_t ) -δk_t = 0 = the steady state denoted by k^* sf(k) = sy = i Graphically the steady state is found where the depreciation-line (chapter 11) or required investment line (chapter 12) is crossing the investment line. Investment per worker has the same shape as the production function (output per worker) but is lower by the factor s (the saving rate).

Answer 71

* No affect in the long run (in the long run, the growth rate of output is equal to zero, no matter what the saving rate is – it will be at its steady state). * The saving rate determines the level of output per worker in the long run. Other things being equal, countries with a higher saving rate will achieve higher output per worker in the long run. * An increase in the saving rate will lead to higher growth of output per worker for some time, but not forever (the steady state level increases) and the investment-curve rotates up. The saving rate affects the level of output per person—but not its rate of growth ==\> growth rate is determined by technological progress

Answer 72

The golden rule level so s, s_GR(k/n)_GR is the value of steady-state k/n that maximises consumption per person, c/n. In steady state, C/N is equal to Y/N - δK/N * For s between zero and sG (G for golden rule), a higher saving rate leads to higher capital per worker, higher output per worker, and higher consumption per worker. * For s larger than sG , increases in the saving rate still lead to higher values of capital per worker and output per worker; but they now lead to lower values of consumption per worker ==\> This is because the increase in output is more than offset by the increase in depreciation due to the larger capital stock. * C = (1-s)Y (if S = 1 ==\> consumption will be zero). If s is high consumption will be lower but investment, capital, and output high (pushes consumption up

Answer 73

The optimal saving rate that maximizes C at the steady state differs from exercise to exercise. To find the optimal s, you will have to write up C\* as a function of k\* and then figure out what k\* is. 1. Express C^* as a function of s 2. Take the deriviative of C^*with respect to s 3. Set the deriviative equal to 0 and solve for s to get the golden rule value of s (optimization-problem and thus setting equal to zero) The golden saving rate is where the difference/gap between f(k\*) and k\* is biggest.

Answer 74

The state of technology tells us how much output can be produced from given amounts of capital and labor at any time.   Y = F(K, AN)

Answer 75

AN = effective labor; doubling A (technologic state) we only need half N to produce the same Y and (if A doubles we can also think of it as we are now having twice as many workers, N).

Answer 76

Conclusions in the two chapter are the same despite that output can grow forever in chapter 12 due to technologic progress. In chapter 12 we are focusing on output per effective worker Y/AN and capital per effective worker (K/AN) in stead of output per worker Y/N and capital per worker K/N.

Answer 77

The straight line is now equal to not only the depreciation rate but also the increase in effective workers (from technological progress), which is equal to: g_A (technological progress) + g_N (population growth) I/AN (or i^r) = (δ + g_A + g_N) K/AN

Answer 78

The steady state decreases because the required investment line becomes steeper (an increase in break-even investment).

Answer 79

The steady state increases because the required investment line becomes flatter (a decrease in break-even investment).

Answer 80

See picture Said differently, the steady state is characterized by the growth rate of output being equal to the growth rate of capital, itself being equal to the sum of the growth rate of population and the rate of technological progress. **This is called balanced growth:** capital, output and effective labor (AN) grow at the same rate g_N + g_A At the same time output per worker and capital per worker grow at the same rate: g_A **Steady state = Long run = Balanced growth**

Answer 81

Balanced growth = long run = steady state In steady state, output per effective worker and capital per effective worker are constant. Put another way, output per worker and capital per worker grow at the rate of technological progress. Put yet another way, output and capital grow at the same rate as effective labor, and therefore at a rate equal to the growth rate of the number of workers plus the rate of technological progress. When the economy is in steady state, it is said to be on a balanced growth path.

Answer 82

* **Investments in R&D** * **Fertility of research:** Understood as number of ideas generated by the R&D investment ==\> this is related to the education level (human capital) * **Appropriability of research results**: If companies can profit from the research results (patents). If not investments in R&D will be low. If not, the fertility of research in the industry will be low. If one company develops a good product, will another company develop an even better just after?

Answer 83

Capital per worker (K/AN) and output per worker (Y/AN) grow at a rate that is higher than g_A for France, United Kingdom and United States. This output growth rate is higher the further the economy is from its steady state + this also depends on the savings rate (an increase in the savings rate leads to a temporary increase in the growth rate) It looks like Japan is above their steady state.

Answer 84

√x = x^0.5 x^ax^b = x^ab x^a/x^b = x^a-b (x^a)^b = x^ab

Answer 85

k_t+1-k_t = sy - δk_{t (per worker terms)} Then we know that 0 = sy - δk_t sy = i = sf(k) _{y = is the value that we will have calculated in the exercise and should therefore be replaced. After this you can sovle for k* and hereafter solve for y* and c*.}

Answer 86

The neutrality of money in the medium-run means that: * Monetary policies are neutral in the sense that in the medium run it does not affect i or the composition of Y. * Fiscal policies does not affect the level of Y in the medium run either, but it does affect the composition of Y because the interest rate differs from its starting point (which is not the case with monetary policies).

Answer 87

* A devaluation leads to a real depreciation that pushes net exports up. The aggregate demand curve shifts rightwards (output is higher for a given price level). We go from A to A’. * Output goes up, unemployment goes down. Workers bargain for higher nominal wages. Prices go up. * This has an effect on the IS-LM graph. * an increase in prices leads to a real appreciation and to a decrease in net exports: IS shifts leftwards. As a result, output decreases: in the AS-AD graph, we move along the new AD curve from A’ to C. Remember there is an increased risk of an exchange rate crisis related to the use of devaluations.

Answer 88

An exchange rate crisis starts if the financial market believe a currency is overvalued or soon will be devalued. i_t = i\*_t - (E^e_t+1-E_t)/E_t If E^e is lower than E, investors will require a higher domestic interest rate, i. This higher i, will decrease I (and C because it is more expensive to borrow) and thus decrease Y. Solutions: * 1) Try to maintain the the parity by setting a higher interest rate with the risk of creating/worsening a recession. Furthermore there is a risk of selling out all foreign reserves and thus being forced to devalue or to exit the fixed exchange rate system. * 2) Give in and devalue (or exit the fixed exchange rate system)

Answer 89

If Savings \> Investment = trade surplus (lending money out, net creditor) If Savings \< Investment = Trade deficit (borrowing money, net debtor)

Answer 90

Goods market closed economy: 1/1-c1 (c₀- c₁t₀+ G) Delta Y/Delta T = (1/1-c1)\* -c1 Delta Y/Delta G = (1/1-c1) 1/1-c1 - (1/1-c1)\*-c1 = 1-c1/1-c1 = 1 Thus, G and T are not macroeconomically neutral. Y can be affected while still remaining a balanced budget.

Answer 91

LM: M^s/P (= M^d/P) = F(Y, i) IS: Y = C(Y-T) + I(Y, **r**) + G + NX(Y, Y\*, ((1+i)/(1+i^*)\*E^e) IS: Y = C(Y-T) + I(Y, **r**) + G + NX(Y, Y\*, ∈) DUE TO SIMPLIFICATIONS of P^e=P and real interest rate = interest rate: IS: Y = C(Y-T) + I(Y, **i**) + G + NX(Y, Y\*, **E**) Positive vs. negative effects of NX: * Y Negative * Y\* Positive * E or ∈: Negative

Answer 92

1) Express c\* as a function of s 2) Take the deriviative of c\* with respect to s 3) Set the deriviative equal to 0 and solve for s to get the golden rule value of s.

Answer 93

The paradox of thrift states the fact that following an increase in C₀, G (or another exogenous variable), which may be thought of as a desire to decrease savings, s may actually end up unaffected. Why? S will be unaffected in cases where I is independent of income. Ex. if I = b₀or if I = b0 + b₁Y where b₀ = 200 and b₁ = 0 However, even though the nominal amount of savings haven't changed, savings RELATIVE to income (y), which will have increased, will have changed.

Answer 94

The J-curve states the fact that in the real world, NX will increase if ∈ decreases (Marshall-Lerner condition). However, according to the J-curve this will not happen immediately. In the beginning a devaluation of E (∈ decreases) will decrease NC since the quantities don't change immediately. Thus, in the beginning import is becoming more expensive but the quantities of both X and IM is the same. Over time, quantities will adjust and import will decrease as P\* has increased and X will increase as ∈ has decreased. The process takes some time (aprox. 3-9 months)

Answer 95

Nominal money supply is a question of how much money citizens hold in bank deposits and currency. It is an exogenous vairable determined by the central bank. If the central bank wants to decrease money supply, they will SELL bonds to get currency that they can put back into the central bank cellar and thus take the money out of the system.

Answer 96

1) All trade of foreign currency is made with the aim of traing bongs (financial assets) and thus not goods/services. 2) There are no restrictions on trading currency and bonds between countries ==\> Perfect capital mobility 3) Financial investors care ONLY about the expected return (therefore not risk and other factors).

Answer 97

* Fixed: We assume E^e = E and thus i = i\* * You can of course always devalue or change to a flexible exchange system. * Floating: NO reason to assume E^e = E. E^e will typically be different than E and thus the full UIP becomes important: i = i\* - (E^e-E)/E * 1+i = (1+i\*) E/E^e

Answer 98

An automatic stabilizer is making the effect on Y of a change in an exogenous variable smaller. Examples: * Income-dependent taxes * Income-dependent import

Answer 99

* P increase, M^s/P decrease, i increase, I decrease, Z decrease, Y decrease (+multiplier) * P increase, M^s/P decrease, i increase ==\> capital inflow, E increase, EP/P\* increase, NX decrease, Z decrease, Y decrease (+ multiplier The increase in the price level leads to a decrease in the real money stock. This monetary contraction leads to an increase in the interest rate, which leads in turn to a lower demand for goods and lower output.

Answer 100

Y increase, N increase, u decrease, W increase, cost increase, P increase

Answer 101

Regarding E: * Appreciation (changes in a free flowing currency market) * Depreciation (changes in a free flowing currency market) * Revaluation (when having fixed exchange rate systems) * Devaluation (when having fixed exchange rate systems) Regarding EP/P\* * Real appreciation * Real depreciation

Answer 102

Current account balance = Savings (Private) + Public - Investment If Savings (private + public) \> Investment = current account surplus and net creditor If Savings (private + public) \< Investment = current account deficit and net debtor

Answer 103

IS: Y = C(Y-T) + I(Y, i) + G + NX(Y, Y\*, ((1+i)/(1+i\*)E^e) LM: M/P = Y \* L(i) * The first effect, which was already present in a closed economy, is the direct effect on investment: A higher interest rate leads to a decrease in investment, a decrease in the demand for domestic goods, and a decrease in output. * The second effect, which is only present in the open economy, is the effect through the exchange rate: An increase in the domestic interest rate leads to an increase in the exchange rate—an appreciation. The appreciation, which makes domestic goods more expensive relative to foreign goods, leads to a decrease in net exports, and therefore to a decrease in the demand for domestic goods and a decrease in output.

Answer 104

AD: Y = (EP/P\*, G, T) negative, positive, negative **M/P has been removed and replaced with EP/P\*:** Under fixed exchange rates, the central bank gives up monetary policy as a policy instrument. This is why the money stock no longer appears in the aggregate demand relation. EP/P\* is added because we now work in an OPEN economy whereas the "traditional" AD curve is for a closed economy. **Increase in P's affect on output:** * Closed economy: Increase in P, decreased M/P and increased the interest rate (decreasing M^d) * Open economy with fixed exchange rates: Increase in P, increases real exchange rate (EP/P\*) and thus makes domestic goods more expensive and thus decreases NX ==\> Y ==\> Multiplier * NB: in the short run the real exchange rate (EP/P\*) is fixed, but in the medium run the real exchange rate will change due changes in prices

Answer 105

I^r = (δ + g_A + g_N) K/AN δ = Depreciation rate g_A = rate of technological progress g_N = population growth (we assume ratio of employment to population to be constant) g_A + g_N = Growth in effective labor

Answer 106

Y/AN and K/AN is constant in its steady state Thus, Y must grow with the same ratio as AN, which grow with g_A + g_N ==\> The same goes for K

Answer 107

Output per PERSON grows with a rate of g_A (the technological progress) ==\> output grows at the rate of g_{N +}g_A. Subtracting population growth g_N we get that output per PERSON grows at g_A. Output per effective WORKER grows with a rate of 0.

Answer 108

* **R&D** * **Fertility of research:** * Understood as number of ideas generated by the R&D investment è this is related to the education level (human capital) * **Appropriability of research results** * If companies can profit from the research results. If not investments in R&D will be low è patents, the fertility of research in the industry (if one company develops a good product, will another company develop an even better just after?),

Answer 109

k\* is the steady state level og capital per worker (K/N). To find k\* there are three steps: 1) Rewrite the production function into per worker terms (dividing by N) 2) Write down the steady state condition: k_t+1 - k_t = **sy** - δk or equvialently: k_t+1 - k_t = **sf(k)** - δk (because sf(k) = sy = i) 3) Set the change (left side) of the equation equal to 0 and solve for k\*. When you have found k\* you can find y\* by plugging k\* into the equation Y/N found in the beginning and c\* = (1-c)y (if the saving rate is given).

Answer 110

k\* = (s/δ)^3/2 ==\> Inverse of N^x/y y\* = k^1/3 ==\> Simply lower-case k^x/yinstead of K^x/y c\* = (1 - s) y ==\> c\* = (1 - s) k^1/3 s_GR = 1/3 ==\> From K^x/y

Answer 111

**Rotation:** Change in E^e_(fear) + Devalue/Revalue **Move along:** Change in i