Macroeconomics

SUMMER TERM 2020
ECON0016: Macroeconomic Theory and Policy
TIME ALLOWANCE: as specified in the submission window
Answer all questions from Part A and all questions from Part B.
Each question in Part A carries 4 per cent of the total mark, which means Part A is worth 48
per cent; Part B carries 52 per cent of the total mark.
PART A
Answer all questions from this section. For each question, identify the statement as True, False,
or Uncertain, and explain your reasoning (in total of not more than 100 words). The maximum
marks for each question will be given for a full and correct explanation. You may use written,
diagrammatic, and mathematical arguments as appropriate.
A.1 Fixed investment by private firms is sensitive to monetary policy.
A.2 A fall in productivity has no impact on the optimal monetary-policy response curve
(monetary rule curve) used by a central bank.
A.3 A government that runs a constant primary deficit cannot stabilise its debt.
A.4 If wage setters and price setters use adaptive expectations, the credibility of a central
bank’s ability to change the inflation target does not matter.
A.5 When the economy is away from the zero lower bound for nominal interest rates, there is
often a conflict between fiscal policy and monetary policy.
A.6 Conventional monetary policy is effective in stabilising asset prices.
A.7 Ceteris paribus, a surprise announcement of a rise in the world interest rate will be
followed by a period during which home’s exchange rate is depreciating (where home is a
small open economy).
ECON0016 1 TURN OVER
A.8 The reason why a depreciation is predicted to improve the balance of trade is that the
demand for exports and imports is relatively sensitive to prices.
A.9 An economy emerging from a recession will always show a deterioration in the private
sector financial balance.
A.10 For a member of a common currency area, the use of fiscal policy to stabilise countryspecific shocks is unnecessary.
A.11 The “Monetary Rule” or MR curve is downward-sloping in a diagram with output on the
horizontal axis and the inflation rate on the vertical axis.
A.12 A permanent cut in government spending (with no change in taxation) can result in a
new medium run equilibrium with higher unemployment and lower real wages in an open
economy with an inflation-targeting central bank.
ECON0016 2 CONTINUED
PART B
Answer all parts of question B in a total of not more than 1600 words. Answers must be typed;
figures and equations can be hand-written and pasted into the document; you may also paste
data charts and simulation output as appropriate.
Quantitative Easing (QE) is a tool that central banks can use to purchase government debt,
corporate debt or other assets. This policy is referred to as QE or asset purchases. Several
rounds of Quantitative Easing were used in the UK. The following data records cumulative
bond purchases by the Bank of England up to each date shown
2009: £200 billion;
2012: £375 billion;
2016: £435 billion.
(a) Use the models you have studied to explain why central banks used Quantitative Easing
as a policy tool following the financial crisis. [13 marks] (b) Explain the expected transmission mechanisms from the policy choice to economic activity
highlighting your assumptions about the assets purchased by the central bank and the
constraints faced by economic agents including the central bank. [13 marks] (c) How does the openness of the economy affect your analysis in the previous two sub
questions? How is your analysis affected by the fact that the shock was a global one? [13
marks] (d) The ECB announced the extension of its asset purchase programme on December 3rd
2015. This was known as QE2 because it was the second round of the ECB’s quantitative
easing policy. Use column (2) of Table 1 to report what happened to the euro exchange
rate (defined as euro/dollar) when the QE2 policy was announced. Is the outcome consistent with the predictions of economic theory? [13 marks] ECON0016 3 END OF PAPER
Table 1: Impact of ECB QE2 Policy.
(1) (2) (3)
Anticipation effect prior
to the announcement of
QE2
Observed on the
announcement of
QE2
Net change as a result
of adopting QE2
Euro exchange
rate (euro/dollar),
%
+7.3 -2.6 +4.7
10-yr sovereign
bond yields (basis
points)
-24.2 +11.4 -12.8
Equity index for
euro area
+9.2 -3.1 +6.0
Source: M. Middeldorp and O. Wood, Bank Underground 4th March 2015.
ECON0016 4 END OF PAPER