Intermediate Macroeconomics II: Policy Issues — DU B.A. (Hons.) Economics Previous Year Question Papers

1. (i) The time inconsistency problem in monetary policy arises because – (a) Fiscal policy is always expansionary (b) Policymakers cannot commit to future policy announcements (c) Central banks are not independent (d) Inflation expectations are always rational (ii) In the ISPCMR model, the central bank’s monetary rule (MR) is derived from – (a) Minimising inflation and output gaps subject to the Phillips curve (b) Maximising output growth (c) Stabilising the government debttoGDP ratio (d) Setting the interest rate equal to the natural rate (iii) The government budget constraint in nominal terms implies that a primary deficit must be financed by – (a) Decreasing government expenditure (b) Reducing transfer payments (c) Increasing taxes only (d) Issuing bonds or printing money (iv) According to Ricardian equivalence, a tax cut financed by borrowing today will – (a) Increase national saving (b) Increase private consumption (c) Leave aggregate demand unchanged (d) Decrease private saving (v) Rules versus discretion in monetary policy: a key argument in favour of rules is that they- (a) Allow policymakers to respond to unforeseen shocks (b) Eliminate the time inconsistency problem (c) Increase the flexibility of policy (d) Always achieve the lowest unemployment rate (vi) A financial crisis often features fire sales, which refer to – (a) Selling of assets at depressed prices due to urgent liquidity needs (b) Government bailouts of failing banks (c) A sudden increase in stock market prices (d) Voluntary restructuring of loans (vii) The liquidity trap is a situation where – (a) The demand for money becomes perfectly inelastic (b) Fiscal policy becomes ineffective (c) Monetary policy becomes ineffective because interest rates are near zero (d) The central bank loses control over the money supply (viii) Mortgagebased securities (MBS) played a key role in the 2008 financial crisis because – (a) They were riskfree government bonds (b) Their complexity and risk were underestimated by investors (c) They were issued only by central banks (d) They had guaranteed returns (ix) Wholesale funding in the financial system refers to – (a) Deposits from households (b) Shortterm borrowing by banks from other financial institutions (c) Longterm government bonds (d) Equity capital raised from the stock market (x) In the MundellFleming model with perfect capital mobility, under a fixed exchange rate, an expansionary monetary policy leads to – (a) A temporary increase in output (b) A permanent increase in output (c) No change in output (d) A decrease in output (xi) Absolute purchasing power parity (PPP) states that – (a) The real exchange rate is constant (b) The interest rate differential equals expected depreciation (c) The forward rate equals the expected future spot rate (d) The exchange rate equals the ratio of price levels (xii) In the Dornbusch overshooting model, the exchange rate overshoots its longrun value because (a) Prices are sticky in the short run