Tentafrågor - EC7210 Flashcards
Explain what is meant by tax smoothing. What dos tax smoothing imply for the behaviour of the budget balance over business?
Tax smoothing means that the government sets the tax-rate as a ratio over output to be constant over time. (Tt/Yt) = (Tt+1/Yt+1).
This is the optimal way ti set taxes when the distortionary cost caused by taxes is a function that is increasing in tax rate, as the costs are minimised by a constant taxratethat just suffices to sahsty the governments budget constraint over time.
The result that it is optimal to set a constant tax rate over time implies that it is optimal for the government to run budget deficits during recessions when output is lower and government spendings higher and budget surplus during booms when the opposite is true in order to keep tax rate constant.
Looking at the governments budget constraint
Gt + (1+r)Dt = Tt + Dt+1
Where Gt is government spending, Dt government debt, Tt is the amount of tax and r is the interest rate.
Expanding,
Gt + Dt + rDt = Tt + Dt+1
Rewriting
Gt + rDt - Tt = Dt+1 - Dt
Gt + rDt - Tt = ΔDt
Rewriting the optimal tax rate
Tt = Yt(Tt+1/Yt+1)
And substituting in to the budget constraint
Gt + rDt - Yt(Tt+1/Yt+1) = ΔDt
LHS is budget deficit and RHS is debt accumulation.
If the tax rate (Tt+1/Yt+1) is held constant, then as Yt increases in booms, Gt decreases which creates a surplus, and as Yt decreases, Gt in increases, leading to deficits in recessions.
Show how the Evolution of government debt is related to the budget deficit and the primary deficit.
The Government budget constraint is given by……… Personen har fått fel här. Kolla hennes föreläsning
Briefly discuss various solutions to the time-inconsistency problem of monetary policy.
The time-inconsistency problem of the monetary policy means that under discretionary policy making, a central bank has the incentive to set a higher inflation rate that it would under commitment, as this can temporarily lead to higher output in a setting with price rigidity. However, since agents has rational expectations, they know how CB sets inflation and thus π = πe, which in the end do not lead to any increase in output above the natural but, only a increased inflation above the core inflation and thus result in bigger losses for the CB then under commitment.
The more inflation averse the central bank is (that is, the higher μ), the smaller the loss and as μ goes to infinity, CB performs as good as under commitment.
How should CB’s deal with the time-inconsistency problem?
- Using Rules to anchor inflation expectations. The central bank credibility commits to a inflation target. This is a way of tying the hands of the central bankers so they are not free to set inflation as they wish.
- To really make those rules credible, CB’s should be independent so politicians can’t influence central banks, making then pursue more expansionary polices to get re elected. Romer shows that there is a strong negative correlation of CB independent index and inflation rate.
- The CB’s should have conservative (prioritise inflation) or professional governors that set interest rates. Someone with a lot of a integrity and independence from politicians and fiscal atouritis.
Briefly discuss whether governments should intervene in markets. Motivate your answer referring to economic theory discussed in the course. Please write no more than 1.5 pages (maxi-mum). (10 points).
How and whether the government should intervene in markets depends on why we think that fluctuations in in the economy arises. According to the Real Business Cycle (RBC) theory, fluctuations are caused by stochastic productivity shocks (government and technology) to markets without imperfections. However, according to the New-Keynsian models, fluctuations are caused by market imperfections. According to the New-Keynesian models, policies are useful to correct those disturbances while proponents of the RBC theory states that policy is meaningless or possibly harmful. since markets are perfect.
According to the RBC Theory changes in money supply have no effect on real variables (money is neutral) since there is no price-rigidities (completely flexible prices). Therefore, monetary policy has no real effects. Since agents are rational, fiscal policy also has no effect since they now that government spendings do day, means that taxes will be higher tomorrow, so they just smooth there consumption over time.
According to the New-keynesian models, prices do not adjust immediately, hence there are price rigidities and there are possibilities for government to use monetary policies as a stabilisation tool and smooth out business cycles.
Since the New-Keynesian models assume monopolistic competition rather than perfect competitions with only price taking firms. Together with price rigidity, this leads to different prices across firms and inefficient allocations. Firms sets a mark up, higher then there marginal cost.
Therefore, the CB must thus set the nominal interest rate so that no firm has an incentive to change its price even when given the opportunity to do so.
—–With imperfect competition firms can raise profits slightly by making the real wage low, which creates a suboptimal labour supply. There are therefor a inefficient outcome and a violation of the first welfare theorem. ——–
Which three types of price adjustments exists in tte NK framework?
Fisher pricing:
Prices are predetermined buy can vary across periods (time).
Taylor pricing:
The opportunity to change prices is determined deterministically and prices are in effect for the same number of periods. o stochasticity.
Calvo prices:
The Opportunity to change prices is determined stochastically and prices are in effect for a random number of periods.
A shock occur to the economy, and only a fraction of firms can determine their price for a random number of periods.
Explain what is meant by efficiency. How do we determine whether an equilibrium is efficient?
Studentsvar 4/5:
“If the decentralised equilibrium isn’t efficient, it means that there is room for a social planer to dictate a better outcome. For example, if the decentralised level of steady state effective capital is larger then k^g, the equilibrium is not pareto efficient and one could get a permanent increase in consumption if the social planer reduces k below the decentralized level.”
If as long as there are perfect competition, perfect information etc, the first welfare theorem applies and thus the decentralized outcome is pareto efficient.
Pareto Efficient: no one could be made better off without making someone else worse off.
We always think about the decentralised equilibrium in contrast to the social planner’s choice and whether they coincide or not.
What is the first Welfare Theorem?
If markets are competitive and complete, there is a finite number of households and no externalities, the decentralised equilibrium is Pareto Efficient.
That is, no one could be made better off without making someone else worse off.
Explain how the Ramsey-Cass-Koopmans model is related to the Real Business Cycle framework discussed in the course. What generates fluctuations in the RBC framework?
Studentsvar 5/5
“Technology shocks and changes in government purchases are RBC-framwork. In absence of shocks, the economy stays on the balanced growth path. With shocks,
deviations from the balanced growth path is introduced. These deviations depends on the size of the shock correlations with previous shocks, etch.
The foundation of the RBC-theory is the neo-classical Ramsey model. While the Ramsey model are about Long run effects of technological progress, the RBC-theory is about business cycle effects of short run fluctuations in technology.
So Ramsey, they think about potential GDP and how it is affected by technology, in RBC we look at how disturbance to technology creates deviations to the long run trend.
Both models are Walrasien, assuming a perfect setting without any imperfections.
In the RBC framework we introduce uncertainty in terms of real disturbances, such as Technology shocks and changes in government purchases. And labour supply is gets endogenous which allows for fluctuations in employment as a response of shocks as well.
Briefly explain why welfare is difficult to assess in the OLG model.
Studentsvar fullpot
“Welfare is difficult to asses for two reasons.
When comparing the decentralised equlibrium with what a social planer would do, the social planer would have to weight different generations in her objective function, which is difficult.
More over, the decentralised equilibrium isn’t even necessarily pareto efficient if we over accumulate capital. That is if the k* > k^g” Then someone may be made better off without making someone else worse of. “
Detta sker ju närmre Beta är1, dvs ju tålmodigare de unga är- De unga sparar då mer och ackumulerar för mycket kapital, det blir då bättre utfall om vi flyttar resurser till de gamla i alla perioder. Men… fattar inte det här riktigt.
Explain why policy makers typically want to maintain low and stable inflation. What is the best way of achieving such price stability? Motivate your answer referring to economic theory discussed in the course. Please write no more than 1.5 pages (maximum). (10 points)
Studentsvar 9/10:
“There are various costs to society from inflation. With high inflation it becomes harder to make accurate decisions. There are shoe leather costs, that is we hold less money which yields more trips to the bank, tearing on or shoes. It decreases incentives to save and invest. If relative prices to differ by a lot, then consumers do not want to sign up for longer contracts.
Inflation, then makes it harder to plan, commit and make decisions, which comes with real transaction-costs.
Policy makers do want a low and stable inflation to limit the cost on society. However, just setting inflation = 0 with strict inflation targeting isn’t always done in practice. In practice CB have flexibel inflation targets (keeping a eye on output and employment as well) and rates at about 2-3%.
Han visar skillnaden mellan discreation och commitment. CB’s loss-function. Sen tar han typ upp nedanstående nedanstående och får poäng.”
To achieve such price stability policy makers should take in to account that agents has rational inflation expectations, and the policy makers should try to ancoore the inflation expectations. This is best done by: credibility commit to a inflation target. This is a way of tying the hands of the central bankers so they are not free to set inflation as they wish.
- To really make those rules credible, CB’s should be independent so politicians can’t influence central banks, making then pursue more expansionary polices to get re elected. Romer shows that there is a strong negative correlation of CB independent index and inflation rate.
- The CB’s should have conservative (prioritise inflation) or professional governors that set interest rates. Someone with a lot of a integrity and independence from politicians and fiscal atouritis.
The CB should credibly commit to a low inflation rate while still keeping a eye on output and employment.
According to Real Business Cycle theory, should policy makers try to offset economic fluctuations? Motivate your answer.
Studentsvar 5/5
“The Real Bussniess Cycle theory (RBS) argues that policy intervention in the economy has no real effects in society. Therefor there are no room for monetary or fiscal policy in the economy,
It could possible even be harmful. This has to do with the face that he RBC theory believe that business cycle fluctuations are caused by productivity shocks because of chocks/changes in technology or government spendings.
Since the RBC theory also assumes that we have markets without any imperfections, this short run fluctuations will eventually be solved by the market. In their framework we end up in a equilibrium that is Pareto Efficient and fulfills the first welfare theorem.” Här har han fått full pott, men fortsätter:
Because of tis, both that we have perfect markets and pareto efficient equilibrium, the RBC theory don’t believe that policy makers should intervene to try to offset economics functions as the market will end up in equilibrium again which is pareto efficient….. lite mer babbel.
Explain what is meant by time inconsistency of monetary policy. Why does it arise and why may it be problematic? No derivations are required but please motivate your answer
Studentsvar 5/5:
“Time inconsistency in monetary policy means that there is a problem with politician that do not commit to uphold a certain target/inflation rate (*that deviates from the core inflation) and instead set any inflation rate ty deem suitable. This arises since when they set any inflation rate they like (this is = setting inflation under discretion), they will likely set a inflation rate, higher than the core inflation trying to temporarily increase output. However, there is no change in real output since agents have rational expectations and cess to all available information and therefor see right through how policy makers sets inflation. Thus inflation expectations equals real inflation, but higher than the core, while output still is y = yn. So, no increase in real output, but a increase in inflation, we thus have higher prices in the economy without any real income/production improvements. thus there are welfare losses and it’s also problematic if politicians use , monetary policies to get re elected. “ Poängen slutade någon rad ova, men han fortsätter babbla på några rader till som jag inte tar med.
Briefly explain what is meant by the Divine Coincidencein the context of the New Keynesian model.
från wikipedia
“In economics, divine coincidence refers to the property of New Keynesian models that there is no trade-off between the stabilization of inflation and the stabilization of the welfare-relevant output gap (the gap between actual output and efficient output) for central banks.
This property is attributed to a feature of the model, namely the absence of real imperfections such as real wage rigidities. Conversely, if New Keynesian models are extended to account for these real imperfections, divine coincidence disappears and central banks again face a trade-off between inflation and output gap stabilization.”
Discuss the options available to a government seeking to fund a given stream of government expenditure. Would you recommend choosing one option over the other? Why? Motivate your answer referring to economic theory. Please write no more than 1.5 pages (maximum). (10 points) 5
Studentsvar 10/10
“ The two main options for government seeking to find a given stream of government expenditures are by raising taxes or accumulating government debt. This is illustrated by the government budget constraint:
Gt + rDt - Tt = Dt-Dt+1
where the right hand side (RHS) shows the government’s budget deficit and the LHS shows the evolution of the government’s debt.
From studying this, we can see that to finance government spendings, either taxes (Tt) has to be equal to th expenditures without any new debt (ΔDt = 0) or the government will not cover expenditures with there revenues and wil instead cover expenditures by accumulating debt by loaning money.
I think that the optimal choice between raising taxes or accumulating debt depends on the situation for the economy.
One powerful result is the one of tax smoothing. Without making to much calculations, assuming that individuals are rational and have all available information, they know that a tax cut today will be met by an increase tomorrow, meaning meaning that they will not change their lifetime consumption.
For governments to minimise the distortion costs from taxes, one may show that the result to this problem is t Tt/Yt = Tt+1/Yt+1, meaning that the optimal choice is to have constant tax-rates. This in turns means that during recessions, when expenditures are high, they should accumulate debt and during economic booms, they should run a surplus.
Therefore I believe that the government should avoid raising taxes to found a given stream of expenditure and instead accumulate debt when needed, followed by running surpluses. All according to the theory of tax-smoothing. and avoiding distortions by raising taxes on for a example wages, which distorts households incentives.”
Hon tycker han har bra resonemang, men saknar något om Ricardian Equivalence.
Explain what is meant by tax smoothing and why it may be deemed optimal from a policy perspective. (5 points)
Studentsvar 5/5
“Tax smoothing implies that policy makers set the tax-rate so that the path of taxes is smooth over time. Taxes are distorting in the sense that they alter the optimal choice of rational profit maximizing agents, which creates welfare losses assuming that there are no initial market imperfections such as externalities or imperfect competitions etc.
When there are such welfare loses associated with the implementation of taxes, then tax smoothing is the policy choice that minimises distortion costs. that is, that minimises Ct = Yt f(Tt/Yt). The optimal choice is then to set a constant tax rate over time, Tt/Yt = (Tt+1/Yt+1) .
This implies that it is optimal from a policy perspective to run surpluses during economic booms and run deficits during recessions to keep taxes smooth over business cycles”
