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1. ECON 100 Tutorial: Week 24Extra slides for exam revision

   Ayesha Ali a.ali11@lancaster.ac.uk Office Hours: Tuesday 2:00-3:00, LUMS C85

2. Revision: True/False

   Questions 1 – 25 from Last Year’s Week 24 Tutorial Worksheet
3. 1. Interest paid to domestic holders of National Debt is included in the National Income Accounts. False (taxpayers are effectively paying themselves interest) 2. The amount of money, which economic agents in the aggregate actually hold at any given moment, is necessarily equal to the amount supplied. True 3. The amount of money, which economic agents in the aggregate actually hold at any given moment, is equal to the amount they demand to hold. False
4. 4. If the amount of money held by individuals exceeds the amount they demand to hold, Keynesian liquidity preference theory suggests that they spend it on bonds. True (and bond prices rise, implying that interest rates fall) 5. If the amount of money held by individuals exceeds the amount they demand to hold, Friedman’s monetarist theory (neo-quantity theory) suggests that they spend it on bonds. False (answer is ‘goods and services, including imports, so that prices rise generally - inflation) 6. In a world of fixed exchange rates and the absence of foreign exchange controls, it would be impossible for a nation to pursue an independent monetary policy. True (If you fix the price, the amount supplied must be commensurate with that price.)
5. 7. Under the gold standard mechanism, gold imports make it more difficult to export goods and services. True (with an inflow of money, domestic prices rise) 8. Those who feel better off if earnings and prices increase by (say) 10% suffer ‘money illusion’. True 9. The original Phillips curve: an inverse relationship between real wages and unemployment. False 10. The expectations augmented Phillips curve hypothesis is that an inverse relationship between percentage wage increases and unemployment exists only where inflation is unanticipated. True
6. 11. Fiscal policy determines the magnitude of the PSBR. True 12. An increase in the gold and forex reserves shows as a positive entry on the capital account. False (import of gold) 13. Individuals hold money for speculative purposes if they think bond prices will fall. True
7. 14. The quantity theory of money states that an increase in the money supply will ultimately cause a proportional increase in the general level of prices. True 15. When the PSBR is increased, the money supply must also increase. False (bond sales could accommodate the deficit) 16. When the PSBR is increased, the national debt must also increase. True 17. The quantity theory of money implies that the velocity of circulation changes to accommodate changes in the money supply. False 18. Quantity theorists believe that money is an important determinant of the level of real income. False
8. 19. Inflation is an upward prices adjustment to accommodate a higher real resource costs. False 20. Inflation is currency debasement. True 21. Keynes said that ‘inflation is always and everywhere a monetary phenomenon’. False (Friedman said this)
9. 22. Keynes’s speculative demand for money reflects the view that, in a severe depression, monetary expansion is more likely to raise bond prices than other prices. True 23. The speculative demand for money is the need to have money to make speculative purchases. False
10. 23. If residents of Eire bought petrol in Northern Ireland this would show in respectively as a negative entry on Eire’s capital account and a positive entry on the UK’s capital account. False (Eire: current account import/capital account export; UK, vice versa) 24. The demand to hold money is inversely related to the rate of interest because when the interest rate is low people borrow money to buy goods. False 25. The natural rate of unemployment is that rate which is consistent with ‘neutral’ money. True
11. Exam 4 Things to review: Past Exams (questions 30 – 40 approximately) http://www.lancs.ac.uk/sbs/registry/Exams/PastPapers/PastPapers.htm Lecture slides and/or recordings Tutorial Worksheet Problems that relate to class Lectures. Reading material

12. Past Exam Questions2013, 2012, 2011, and 2010

    Note: Solutions are not available to tutors. Answers presented here are subject to error.
13. The hypothesis of the expectations-augmented Phillips curve holds that: employment contracts fully accommodate the rate of price inflation job-seekers never make systematic errors wage settlements are partially determined by the expected rate of price inflation reservation wages are determined by minimum wage legislation 2010 Exam Q32
14. Which of the following statement is true? With the expectations-augmented interpretation of the Phillips curve, Milton Friedman assumes that a) monetary policy is the exogenous variable, that causes variations in unemployment b) trade union activity is the exogenous variable, that causes variations in unemployment c) unemployment is the exogenous variable, that causes variations in inflation d) monetary policy is the exogenous variable, used to counter variations in unemployment 2013 Exam Q33
15. Expectations Augmented Phillips Curve Initially, unemployment and inflation are at point A. Expansionist monetary policy would increase consumption, shifting to point B along the Phillips curve Unemployment is reduced but there is a trade off; inflation. After a short period, agents will associate expansionist policies with inflation and will push for higher wages. (Gerry: Price-wage spiral) This will stop the consumption stimulus and also de-incentivisehiring. Agents will shift their expectations curves to point C.
16. The natural rate of unemployment is the level of unemployment that is consistent with: a high rate of inflation low rate of inflation an absence of monetary disturbance an absence of involuntary unemployment 2010 Exam Q33
17. The hypothesis of rational expectations contends that individuals: do not make systematic errors anticipate future prices accurately adapt slowly to the rate of inflation only make rational errors 2010 Exam Q34
18. Rational Expectations: Rational expectations is a hypothesis in economics which states that agents' predictions of the future value of economically relevant variables are not systematically wrong in that all errors are random.
19. Identify the missing word(s): Goodhart’s Law states ‘that any ____I____ will tend to collapse once pressure is placed upon it for control purposes.’ monetary target observed statistical regularity fiscal budgetary stance structured investment 2010 Exam Q35
20. Goodhart’s Law Any observed statistical regularity will tend to collapse once pressure is placed upon it for control purposes. (Goodhart's original 1975 formulation, reprinted on p. 116 in Goodhart 1981[2])
21. Suppose that national income (measured in 1990 prices) is £1000 billion. Suppose further that prices have doubled since 1990 and that the typical unit of money circulates around the economy 20 times per year. What is the money supply? £50 billion £100 billion £150 billion £200 billion 2010 Exam Q36
22. MV = QP We know that: V = 20 Q = 1000 P = 2 So, solving for M: MV=PQ M = QP/V M = 1000*2/20 M = 100
23. Balance of International Payments Accounts The general structure: BoP ≡ X - M + IOU (loan/credit) ≡ 0 BoP ≡ current account + capital account ≡ 0 income-expenditure ∆wealth ≡ 0 (deficit) (wealth falls) - + (exporting assets or writing an IOU) (surplus) (wealth rises) + - (importing assets or receiving an IOU) NB: the current account surplus is matched by a a ‘capital outflow’
24. If the LM curve is vertical, then: full crowding out occurs fiscal policy will be infinitely effective monetary policy will not work supply side policies will be unavailable 2010 Exam Q38
25. ‘Crowding out’ occurs if new public expenditure a) is insufficient to maintain social services b) creates excess demand and over-full employment c) attracts an influx of economic migrants d) diverts expenditure from existing productive activities 2013 Exam Q31
26. Vertical LM curve If the demand for money is not related to the interest rate, as the vertical LM curve implies, then there is unique level of income at which the money market is in equilibrium. Thus, with vertical LM curve, an increase in government spending (which shifts the IS curve) cannot change the equilibrium income and only raises the equilibrium interest rates. If government spending is higher and the output is unchanged, there must be an offsetting reduction in private spending. In this case, the increase in interest rates crowds out an amount of private spending equal to increase in government spending. Thus, there is full crowding out if LM is vertical.
27. With Keynes’s speculative/asset demand to hold money, speculation is in respect of a likely change in: (a) the inflation rate (b) the exchange rates (c) bond prices (d) equity prices 2012 Exam Q31
28. UK National Debt comprises: (a) the sum of trade deficits over past years (b) sterling currency notes and coins in circulation, plus commercial bank deposits (c) outstanding loans to the state, excluding sterling currency notes and coins in circulation (d) outstanding loans to the state, including sterling currency notes and coins in circulation 2012 Exam Q32
29. As defined in Keynes’s General Theory, ‘involuntary unemployment’ relates to individuals whose employment prospects would be raised by: (a) a rise in the price of wage goods (i.e., a rise in the cost of living) (b) a fall in the price of wage goods (i.e., a fall in the cost of living) (c) greater trade union participation (d) a shift to capital-intensive production methods 2012 Exam Q33
30. As defined in Keynes’s General Theory, ‘involuntary unemployment’ relates to individuals whose employment prospects would be raised by a) a rise in the price of wage goods (i.e., a rise in the cost of living) b) a fall in the price of wage goods (i.e., a fall in the cost of living) c) greater trade union participation d) a shift to capital-intensive production methods 2013 Exam Q30
31. Keynes on involuntary unemployment “Clearly we do not mean by ‘involuntary’ unemployment the mere existence of an unexhausted capacity to work. An eight-hour day does not constitute unemployment because it is not beyond human capacity to work ten hours. Nor should we regard as ‘involuntary’ unemployment the withdrawal of their labour by a body of workers because they do not choose to work for less than a certain real reward. Furthermore, it will be convenient to exclude ‘frictional’ unemployment from our definition of ‘involuntary’ unemployment. My definition is, therefore, as follows: Men are involuntarily unemployed if, in the event of a small rise in the price of wage-goods [i.e., consumer goods] relatively to the money-wage [i.e., nominal wage], both the aggregate supply of labour willing to work for the current money-wage and the aggregate demand for it at that wage would be greater than the existing volume of employment.”
32. If a UK resident citizen buys a BMW car from Germany and the car exporter uses the payment to buy UK government bonds, which of the following statements would be true? (a) UK net exports fall and net capital exports fall (b) UK net exports rise and net capital exports rise (c) UK net exports fall and net capital exports rise (d) UK net exports rise and net capital exports fall 2012 Exam Q34
33. Net Exports If a UK resident citizen buys a BMW car from Germany This is a German export and UK import of a tangible good The car exporter uses the payment to buy UK government bonds This is a German import and UK export of a capital good
34. The original Phillips curve identified a robust correlation between: (a) unemployment and the rate of change of real wage rates (b) unemployment and the rate of change of money wage rates (c) wage levels and unemployment (d) wage levels and inflation 2012 Exam Q35
35. Indicate which one of the following statements is true. With the original interpretation of the Phillips curve, A.W. Phillips assumes that a) wage bargaining is the exogenous variable, that causes variations in money wages b) the business cycle (as reflected in the unemployment rate) is the exogenous variable, that causes variations in increases in money wages c) the real wage is the exogenous variable, that causes variations in inflation d) inflation is the exogenous variable, that causes variations in unemployment 2013 Exam Q32
36. Phillips Curve Inflation is a change in money wages
37. According to Friedman’s re-interpretation of the Phillips Curve, if inflationary expectations rise, the Phillips curve: a) shifts down b) shifts up c) becomes flatter d) becomes steeper 2011 Exam Q32
38. Expectations Augmented Phillips Curve Initially, unemployment and inflation are at point A. Expansionist monetary policy would increase consumption, shifting to point B along the Phillips curve Unemployment is reduced but there is a trade off; inflation. After a short period, agents will associate expansionist policies with inflation and will push for higher wages. This will stop the consumption stimulus and also de-incentivisehiring. Agents will shift their expectations curves to point C.
39. If job seekers under-estimate the rate of inflation, the duration of the job-search: (a) shortens, so that unemployment tends to rise (b) lengthens, so that unemployment tends to fall (c) shortens, so that unemployment tends to fall (d) lengthens, so that unemployment tends to rise 2012 Exam Q36
40. If job seekers under-estimate the rate of inflation Then they will over-estimate the value of an offered wage contract And will accept a lower real wage And thus will have a shorter period of unemployment
41. Fiscal monetarists argue that inflation is a consequence of excessive growth in: (a) revenue from taxation (b) national debt (c) the money supply (d) national output 2012 Exam Q37
42. Fiscal monetarists argue that inflation is a consequence of excessive growth in a) revenue from taxation b) sovereign debt c) the money supply d) national output 2013 Exam Q36
43. The Taylor Rule is a representation of monetary policy whereby the short-term nominal interest rate is varied systematically with respect to: (a) the trade deficit and the value of sterling (b) employment and the cost of living (c) inflation and the ‘output gap’ (d) tax revenues and the level of government borrowing 2012 Exam Q38
44. Taylor rule The Taylor rule equation is written as: rt = r*+ π* + w(πt – π*) + (1 – w)(yt– y*)/y* where: rtis the central bank discount rate y is the GDP πt is the inflation rate y* is the potential GDP π* is the inflation rate target w is the policy parameter
45. Define r as the real rate of interest and let r* be the rate consistent with long run equilibrium in the economy. Further, define π as the rate of inflation and π* as the target rate of inflation. Then r = r* + α(π – π*) is: an LM curve a Taylor rule a DSGE model incomprehensible 2010 Exam Q39
46. By the Taylor Rule, nominal interest rates are raised whenever: a) inflation falls b) the output gap widens c) the output gap closes d) the inflation target is raised 2011 Exam Q36
47. By the ‘Lucas critique’, economic forecasts are: (a) always unreliable (b) most reliable when economic policy is stable (c) most unreliable when a change in economic policy is implemented (d) most unreliable when inflation is accelerating 2012 Exam Q39
48. According to the ‘Lucas critique’, economic forecasts are a) always unreliable b) most reliable when economic policy is stable c) most unreliable when a change in economic policy is implemented d) most unreliable when inflation is accelerating 2013 Exam Q38
49. Policy instruments and objectives Theory of Economic Policy (Lecture 57 Slide 42) New Classical Economics – the Lucas critique Economic forecasts are most unreliable when they are most needed; i.e., when a change in economic policy is to be implemented Even if individuals’expectations could be forecast in the context of current policy structures, that ‘success’ is undermined when that policy structure changes New policy implies a new context in which decisions are taken: so individuals’ reactions are affected Behavioural adjustments to changes in policy structures emasculate macroeconomic forecasting and (with it) aggregate demand management Robert Lucas (1937 - ) Nobel Prize 1995 … ‘for having developed and applied the hypothesis of rational expectations, and thereby having transformed macroeconomic analysis and deepened our understanding of economic policy’
50. When the Bank of England undertakes quantitative easing: (a) long-term government bonds (gilts) are bought using newly created money (b) the composition of the national debt is altered (c) the volume of the national debt remains constant (d) all of the above 2012 Exam Q40
51. Quantitative easing is a process whereby a central bank: a) sells long-term government bonds b) purchases long-term government bonds c) sells short-term government bonds d) purchases short-term government bonds 2011 Exam Q35
52. What is quantitative easing? Expansionary monetary policy usually involves the central bank buying short-term government bonds in order to lower short-term market interest rates. If they keep doing this, it will eventually stop working – that is when the economy is falls into a liquidity trap. A liquidity trap can occur when short-term interest rates are either at, or close to, zero, so that normal monetary policy can no longer lower interest rates. (Zero is the lower bound on interest rates – meaning they can’t be lower than zero – meaning bonds have to give at least a zero return.) This is when central banks use quantitative easing. Quantitative easing is when central banks purchase long-term assets (including bonds, gilts, real estate) in an attempt to lower the long-term interest rate and increase money supply.
53. Which of the following is not a function of the Bank of England? lender of last resort supplier of money acting as a store of value determining the official interest rate 2010 Exam Q40
54. For UK international payments, the ‘balance for official financing’ is the value of: a) net exports including ‘invisibles’ b) foreign exchange reserves c) net UK borrowing from foreign central banks d) foreign exchange bought/sold to maintain the exchange value of sterling 2011 Exam Q38
55. The balance of international payments is a) a corollary of the government’s overseas borrowing b) a measure of an economy’s indebtedness c) the overseas aid budget of a nation state d) an accountancy identity 2013 Exam Q34
56. In the context of the balance of international payments, a residual for ‘official financing’ indicates the extent to which the monetary authority a) sells domestic currency to increase holdings of foreign exchange reserves b) sells foreign exchange reserves to support the value of the domestic currency c) allows the international value of its currency to be determined by market forces d) is taking advantage of a trade surplus to build its foreign exchange reserves 2013 Exam Q39
57. Balance of International Payments Accounts (Lecture 61 Slide 35) The general structure: BoP ≡ X - M + IOU (loan/credit) ≡ 0 BoP ≡ current account + capital account ≡ 0 BoP ≡ X - M + ‘invisibles’ + DLT + DST + Dforex ≡ 0 BoP ≡ { balance for official financing } + Dforex ≡ 0 (exports of gold and/or forex to support £) balance for official financing: the amount taken from (or absorbed by) official forex reserves in order to stabilise the international value of domestic currency
58. With the Keynesian (liquidity preference) theory the interest rate is determined by: a) the asset demand to hold money b) the speculative demand to hold money c) expectations relating to future bond prices d) all of the above 2011 Exam Q37
59. A nation with a fixed exchange rate cannot insulate itself from world inflation because, if initially its domestic inflation rate is lower than elsewhere: a) economic recession forces domestic prices up b) domestic goods become less competitive and cost-push inflation raises domestic prices c) domestic goods become more competitive which tends to increase money in domestic circulation d) none of the above 2011 Exam Q39
60. Under a fixed exchange rate Low domestic inflation will cause the price of goods to rise more slowly than in other countries So other countries will seek to buy goods from the low inflation country This will increase the amount of capital in the low inflation country This will put upward pressure on the low inflation country’s currency
61. ‘Ricardo equivalence’: borrowing by the state is equivalent to ... I ... (whether currently or else deferred by borrowing). Robert Barro set Ricardo equivalence within the context of Keynesian macroeconomics, where the implication is that ... II ... government expenditure gives no boost to aggregate demand, since it is offset by ... III ... to meet ... IV .... In order: missing words are: I II III IV a) raising taxation tax-financed spending living costs b) reducing taxation IMF-financed depreciation borrowing costs c) raising taxation High default an exchange rate target d) raising taxation bond-financed saving future tax demands 2013 Exam Q35
62. The ‘Bank Rate’ (the key short-term rate set by the Bank of England) is the repo rate. A repo is a repurchase agreement whereby a) a commercial bank sells the central bank a security, with an agreement to repurchase that security, on a given date, at a higher price. b) a commercial bank sells the central bank a security, with an agreement to repurchase that security, on a given date, at a lower price. c) the central bank sells a commercial bank a security, with an agreement to repurchase that security, on a given date, at a higher price. d) the central bank sells a commercial bank a security, with an agreement to repurchase that security, on a given date, at a lower price. 2013 Exam Q37
63. A structural fiscal deficit exists when sovereign net borrowing is a) negative even as an economy is producing at full capacity b) positive even as an economy is producing at full capacity c) rising even when austerity measures are in place d) negative even as an economy is producing at full employment 2013 Exam Q40