Midterm 2

Question 1

IS curve

Answer 1

inverse relationship between output Y and real interest rate

Question 2

what does equilibrium mean for the IS curve?

Answer 2

output = planned output (C + Ipl + G + NX)

Question 3

IS curve: consumption

Answer 3

autonomous C
- consumer confidence
- household wealth
- expected future income

related to:
- autonomous consumption (+)
- disposable income (+)
- real interest rate (-)

Question 4

IS curve: investment

Answer 4

autonomous I
- business confidence
- expected future profits/cash flow
- changes in technology

related to:
- autonomous investment (+)
- real interest rate (-)

Question 5

IS curve: net exports

Answer 5

autonomous NX
- domestic preferences for foreign goods
- foreign preferences for domestic goods
- foreign trade barriers

related to:
- autonomous net exports (+)
- real interest rate (-)

Question 6

Phillips curve

Answer 6

inverse relationship between unemployment and inflation

Question 7

Okun’s law

Answer 7

relationship between unemployment gap and output gap

Question 8

repo

Answer 8

short for repurchase agreement or sale and repurchase agreement

Question 9

what happens in a repo?

Answer 9

CB borrows money by agreeing to sell bonds at t0 to p0

repurchase bonds at date t1>t0 and p1>p0

Question 10

what happens in a reverse repo?

Answer 10

CB lends money by agreeing to purchase bonds at t0 at p0

sell bonds at date t1>t0 and p1>p0

Question 11

three key equations in monetary policy response

Answer 11

optimal shock response

rate-rule

IS curve

Question 12

how to calculate output gap?

Answer 12

percentage deviation of aggregate supply from potential output at a given point of time

Yt - Yp/Yp = ln(Yt) - ln(Yp)

Question 13

how to calculate unemployment gap?

Answer 13

difference between unemployment rate and natural rate of unemployment at a given time

ut - un

Question 14

how to get optimal rate rule from loss function?

Answer 14

sub phillips curve

minimisation for optimal path

sub dynamic is curve

isolate rt

Question 15

fisher’s equation

Answer 15

r = i-pi

Question 16

phillips’ fit to original data

Answer 16

wage inflation = -0.9 + 9.683u^(-1.394)

Question 17

policy rate, government bond rate, lending rate

Answer 17

policy rate set by CB
government bond rate set by bond market
lending rate set by commercial banking system

difference between government bond rate and policy rate is the term spread

difference between lending rate and government bond rate is the credit spread
- depends on riskiness of the loan and risk tolerance of the bank

Question 18

what do loops in the Phillips curve tell us?

Answer 18

time matters

wage inflation can depend on the rate of change of inflation and the rate of change of demand for labour (and therefore unemployment)

Question 19

supply shocks

Answer 19

events affect inflation independent of labour market conditions and/or inflationary expectations

Question 20

dual mandate of the central bank

Answer 20

keep inflation as close as possible to target inflation

keep output as close as possible to potential output

Question 21

primary policy tool of central banks

Answer 21

nominal short-term interest rates (Fed Funds Rate in the US)

Question 22

what is the Fed Funds Rate?

Answer 22

interest rate that banks lend to one another on an overnight loan of excess reserves

Question 23

how does the Fed control the amount of reserves in the banking system and the Fed Funds/policy rate?

Answer 23

repo and reverse repo (open market operations)

Question 24

how else can the central bank control the overnight rate apart from repos?

Answer 24

changing the reserve requirement or paying interest on reserves

Question 25

what do aggregate demand shocks do?

Answer 25

move the IS curve

positive demand shocks cause economic output to increase
negative demand shocks cause economic output to decrease

Question 26

what do aggregate supply shocks do?

Answer 26

change the Phillips curve or production function

positive supply shocks cause inflation to decrease
negative supply shocks cause inflation to increase

Question 27

business cycles are caused by sequential shocks to:

Answer 27

production function (supply shock)

IS curve (demand shock)

Phillips curve (supply shock)

Question 28

non-activists

Answer 28

wage and prices flexible so economy is self-correcting quickly

government activity to reduce high unemployment is unnecessary

classical school of thought

Question 29

activists

Answer 29

wages and prices are sticky so slow self-correcting mechanism

government activity to reduce high unemployment is justified

keynesian school of thought

Question 30

neither monetary nor fiscal policy can response immediately

Answer 30

data lag
recognition lag
legislative lag
implementation lag
effectiveness lag