Macroeconomics Exam Questions - Short-run and Long-run Effects of Monetary and Fiscal Policy

Question 1 - European Central Bank's Promise to Buy Bonds and Keep Interest Rates Low

1.“The European Central Bank has kept its promise to buy bonds under its quantitative easing programme until the end of September and keep interest rates at their current record lows “well past” the end of their asset purchases” April 26th, 2018, Financial Times.

a. Show the short-run effects of this expansionary monetary policy on both graphs and explain. What happens to r, Y and P?

b. Show and explain (labor market) what happens in the transition from the short run to the long run. What happens to r, Y and P?

c. How do the new long-run equilibrium values of the endogenous variables compare to their initial values?

Show your work below (Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium values; iv. the direction the curves shift; and v. the terminal equilibrium values.) briefly and precisely.

“U.S. Budget Deficit Widens on Lower Revenue, Higher Spending” Wall Street Journal, April 11th, 2018 – Assume G (government spending) goes up

a. Please use the AD-AS diagrams below [Hint: Both LRAS and SRAS] and show the short-run effects on the graph below and briefly explain. What happens to Y and P?

b.Show (with arrows) and explain what happens in the transition from the short run to the long run [Hint: Labor market]. What happens to Y and P? Show your work below (Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium values; iv. the direction the curves shift; and v. the terminal equilibrium values.) briefly and precisely. [Hint: Exactly like we did in our lecture slides]

c.How do the new long-run equilibrium values of the endogenous variables compare to their initial values?

d. If you were in charge of monetary policy and would like to counter the impact of this government spending increase, which policy would you implement? Why?

Consider the economy of Hicksonia. 

a. The consumption function is given by C = 300 + 0.6 ( Y − T ). The investment function is I = 700 − 80 r. Government purchases and taxes are both 500. For this economy, graph the IS curve for r ranging from 0 to 8.

b. The money demand function in Hicksonia is ( M / P ) d = Y − 200 r. The money supply M is 3,000, and the price level P is 3. Graph the LM curve for r ranging from 0 to 8.

c. Find the equilibrium interest rate r and equilibrium income Y.

d. Suppose that government purchases are increased from 500 to 700. How does the IS curve shift? What are the new equilibrium interest rate and income?

e. Suppose instead that the money supply is increased from 3,000 to 4,500. How does the LM curve shift? What are the new equilibrium interest rate and income?

f. With the initial values for monetary and fiscal policy, suppose the price level rises from 3 to 5. What happens? What are the new equilibrium interest rate and income?

g. For the initial value of monetary and fiscal policy, derive and graph an equation for the aggregate demand curve. What happens to this aggregate demand curve if fiscal or monetary policy changes, as in parts (d) and (e)?

Independent Research

Please find a recent article (three (3) months old, or newer) related to a fiscal or monetary policy change or an external shock. Summarize it in one paragraph and connect it to the material we covered in class in chapters 10, 11 and 12, using equations, graphs and our models. Analyze the impact of the policy change/shock using AS-AD and IS-LM models. According to our models, how do the endogenous variables change? (Y, r, P, up, down?) Do the results from our models contradict or overlap with the predictions on the article? Please cite the article and include the link to it.