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2 The Global Macroeconomy (Subject) / Quiz (Lesson)

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• The three aspects of monetary policy The three aspects of monetary policy. The central bank uses instruments of monetarypolicy to achieve an outcome for an intermediate target and in that way control its ultimate target, usually inflation. Operational Instruments of Monetary Policy - Short-term market interest rates, reserve requirements Intermediate Targets - Indicators with a reliable connection with future inflation e.g. money supply, exchange rate, inflation forecast to keep price level under control Ultimate Policy Target - Normally inflation, but could also include reference to output or employment.
• The CA of a country is in Deficit CA=X-Z+NFI when the sum of the trade balance and of net foreign income is negative CA = (S-I) + (T-G) when investment of a country exceeds savings of a country (Public & Private!)
• The Curse of Raw Materials Says countries with a lot of natural resources often have weak economic performance MDP
• Which of the following statements about Growth are true? (ALL) (1) Solow growth model relies on the assumption that the marginal product of capital is  decreasing(2) After the second world war, the marginal product of capital in Germany was highIf depreciation is higher than investment, the stock of capital decreases(3) The growth of Asian countries such as South Korea and Singapore between1966 and 1990 was driven NOT mostly by TFP increases  (4) TFP differences accout for most of the variation in GDP per capita across countries(5) Low levels of HK in a country hinder its convergence process(6) Major inventions take time before affecting the Production Process & Productivity growth (7) Institutions can be persisten over time because political systems may perpetuate
• Genuine Savings Rate GDP - total consumption = Gross Investment (I) or Gross Savings (S) GDP + educational expenditure (Inv. in HK) - depreciation - depletion (energy, minderal, forest) - C02 Damages
• Moral Hazard Moral hazard occurs when someone increases their exposure to risk when insured. This can happen, when a person takes more risks because someone else bears the cost of those risks. b) moral hazard is not a method to diversify risk a) the more banks are insured, the less they are prone to risk taking
• When assets have positive or zero correlation with one another it is possible to diversify risk by investing in several of them Decrease Unsystematic risk Negative Outstanding 0.0 to 0.5 Excellent 0.5 to 0.6 Very Good 0.6 to 0.7 Good 0.7 to 0.8 Ok to poor 0.8 to 0.9 Poor to bad 0.9 to 1.0 Worthless Hedging with Gold Prices of financial assets like stocks and bonds, and non-financial assets like gold move in opposite directions due to inflation. High inflation - rise in gold prices High inflation - fall in prices of financial assets
• Fiscal Policy Expansion increases interest rate for a given Monetary Policy Keynesian cross refers to the fiscal multiplier a fiscal policy expansion increases the interest rate for a given monetary policy a fiscal policy expansion increases output, but less as there is crowding out for a given monetary policy Shift in the IS curve to the RIGHT by Keynesian Multiplier  value of tax multiplier times * reduction in taxes ΔT x MPC/1-MPC Strong increase > ΔY and i Crowding out of private investment as  result of i ↑
• Fiscal Policy Contraction decreases Aggregate Demand & Inflationary pressure for a given Monetary Policy Increase t to reduce Y by Keynesian Multiplier Rise in T will lead to the decrease in aggregate demand Decrease in aggregate demand will help in controlling inflation.
• Policy plays does not play a role in the Solow growth model Demand does not lead to growth All growth is driven by savings schedule (Capital Accumulation) Long run: Everything is driven by TFP (can be very far away)
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• LM curve presents liquidity preferences & supply of Money Shock to Money Demand = innovation of contactless card can be a shock Upward Shift: Rising interest rate  LM curve presents liquidity preferences & supply of Money
• IS-LM curve is not an optimal model, but the best reduced form Short-Run Model IS-LM curve is the best reduced form Short-Run Model (not Optimal) IS-LM curve does not consider the yield curve IS-LM curve is useless for ZLB Problem lower bound New Keynesian model: Inflation Expectation
• The theory of PPP suggests that, in the long-run, exchange rates are determined by: relative price levels
• ZLBP Situation in which central bank of a country wants to lower short-term nominal interest rates, but faces hindrance when interest rate reaches or nears zero, and cannot lower it further Central Bank wants to stabilize econ, but cant  1) Zero interest rate would trigger withdraw  money from commercial banks and hold it in cash (would cost to place money in bank) 2)Zero interest rate would give 0 nominal return to the banks instead of the negative nominal return they would receive.  The Great Recession of 2007 brought the ZLBP to a reality when the Federal Reserve sharply lowered the target for the federal funds rate. In December 2008, the federal funds rate was set to the zero lower bound (more precisely in a target range from zero to 25 basis points), and has remained there since then. [4] Even before the United States, Japan had already faced the pangs of ZLBP in the 1990s, and they could overcome the problem by banking on zero interest rates, and the intervention of the Fiscal Policy. [5] ZLBP is a feared phenomenon for the effects that it leaves such as deflation, increase in holdings in cash, decrease in return to commercial banks, and others. The central bank’s involvement, primarily, seeks to attain a targeted inflation rate, and maintain it, but the advent of a ZLBP leads to the opposite as deflation surfaces. One can also argue that ZLBP is a Liquidity Trap based on the principle that both the concepts revolved around lowered interest rates. However, in a liquidity trap, despite the central banks efforts to lower the interest rates, the interest rates do not show any decrease.
• 3 Factors to make Exchange Rate Rise -Increase in domestic interest rate-decrease in foreign interest rate-increase in expected future exchange rate
• Suppose the economy has perfect capital mobility and a flexible exchange rate. What would cause an increase in a countrys equilibirum real interest rate a foreign monetary policy contraction
• Suppose the economy is in general equilibrium and inflation is at the central bank's target. The economy then experiences a positive short-run supply shock that decreases the inflation gap by one percentage point and increases the output gap by one percentage point. Then, according to the Taylor rule: the real interest rate target would not change
• Suppose the economy is at the zero lower bound with a negative output gap. If financial frictions then decrease, there would be: rightward shift of the AD curve
• The magnitude of the shift of the short-run aggregate supply curve in response to an aggregate demand shock is determined by: the credibility of the monetary authorities
• 3 Supply Shocks 1) accomadating policy to maintain zero output gap 2)exstinguishg policy- maintaining zero inflation 3) neutral policy- stabilizing nominal gdp
• fiscal policy includes gov purchases  gov transfer pay personal income/tax corp income or tax
• Relationship between fiscal multipliers and the "zero lower bound"? When monetary policy has hit the zero lower bound, fiscal multipliers are likely to be largerthan normal.
• Does Ricardian equivalence affect AD and AS? -it does not affect AD but still can affect output and inflation through moves in AS with tax cuts-budget deficits that arise from lowering taxes without changing purchases are not a burden on future generations because as government saving falls, private saving rises
• The Following Implications about the Steady State are True Countries will eventually reach their Steady State In the Stready State, long-run growth only comes from TFP (i.e. for OECD countries) Countries in the Steady State no longer grow from Capital Accumulation Richer countries grow slower than poorer ones Higher ROI in poorer countries, therefore, poor countries are moving towards Steady State faster Technology progress has a double dividend: (1) Shift frontier and (2) Approach efficient frontier by increasing TFP
• The Yield Curve Normal Economy: Positive, interest rate increases with maturity of Bonds Recesion; Negatively skewed:  Short term-interest rate higher than long-term interest rate Short-Term Bonds are cheaper Expectations of falling interest rate Weak Demand for Short-Term Bonds
• Liquidity vs Solvency Liquidity crisis = Ability to cover current liabilities quickly with current assets Solvency = Ability to have enough assets to cover assets Solvency crisis worse than liquidity crisis Solvency crisis: Lehman Brothers (Debt > Assets) - Access to funds at FED but cannot meet liabilities Greece = Debt Rate of 160%, has to Bailout to receive new funds Liquidity crisis: In in Germany (60% Debt Level) Bond Demand declines, 
• ­The currency with higher interest rate should depreciate on average TRUE
• ­The currency with lower interest rate should appreciate on average TRUE
• ­If PPP holds (RER=1), a country with relatively lower inflation will see its nominal exchange rate appreciate TRUE
• ­In the long-run, a country with relatively higher prices will see its nominal exchange rate depreciate TRUE
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• ­There are zero excess returns on average from a “carry” trade TRUE
• ­The augmented UIRP states that the average profits from the carry strategy equal the currency risk premium TRUE
• ­Uncovered IP assumes a No-Arbitrage Relationship TRUE
• ­The multiplier is stronger in a recession >1, because people are more financially constrained and their MPC is higher TRUE
• ­At ZLB, fiscal expansionary policy has greater effects, the fiscal multiplier is higher because crowding out of investment is lower (interest rates are low anyways and there is no incentive to save at 0 interest rate) TRUE
• ­At ZLB, fiscal expansionary policy has greater effects, the fiscal multiplier is higher because crowding out of investment is lower (interest rates are low anyways and there is no incentive to save at 0 interest rate) TRUE
• Unexpected inflation reduces the real return on a loan, so wealth moves from the lender to the borrower. TRUE
• Uncertainty about future inflation rates and the real rate of return on loans is problematic for the economy overall because: As long-term lending become more costly and less common, the economy invests less.
• A positive shock to the AD curve will cause inflation to __________ in the short run and growth to ___________ in the short run. A positive shock to the AD curve will cause inflation to ____increase ______ in the short run and growth to ______increase ______ _____ in the short run.
• long-run aggregate supply curve and a short-run aggregate supply curve can help demonstrate what effects in a real economy? The effects of sticky prices and wages.
• More wealth per capita is derived from produced capital relative to natural capital when income increases. x

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