FACULTY OF ECONOMICS AND MANAGEMENT UNIVERSITI PUTRA MALAYSIA
FINAL EXAM (TAKE HOME) SEMESTER I, 2012-2013
Registration no :
(in words)
____________________________________________________________________
This question sheets consist of 1 printed page only, excluding this page.
ECN6114: ADVANCED MACROECONOMICS
INSTRUCTIONS: 1. Answer all question.
2. Answers should be hand written.
19 DECEMBER 2012 Deadline: 4 JANUARY 2013
1
1. Consider a Central Bank that maximizes the following utility function:
)2
( )
(y ye T
k
Z
where k is a positive constant. Its policy instrument is the growth rate of the money supply, M. Assume that the inflation target is T 0.
i. Explain this utility function by focusing on how the central bank’s utility rises with output. Is this central bank ‘over-ambitious’?
ii. Now assume that the central bank sets the money supply growth rate after economic agents have incorporated their expectations about inflation into their decision-making, and thus faces a Phillips Curve:
)
( e
E yy
a. Assuming that agents have rational expectations, solve algebraically for the optimal inflation rate under discretion.
b. Suppose that, before private-sector inflation expectations were formed, the central bank could commit to a particular rate of inflation. What would that rate be? Discuss.
2. ‘The Golden rule is attractive because although it has some drawbacks, it is superior to an arbitrary x% deficit rule on economic grounds and easy to explain to the public and to monitor’. Asses this statement.
3. a. What is meant by the term ‘random walk’? Under what conditions will consumption follow such behavior?
b. Explain how the introduction of adjustment costs and imperfect competition alters the modeling of investment.
4. Use the Mundell-Fleming model for fixed and flexible exchange rate regimes and assume perfect capital mobility. Suppose there is a fall in the world interest rate.
i. Does this have an expansionary or contractionary impact on output in a small open economy? Explain your answer
iii. Does the trade balance improve or deteriorate? Explain your answer.
5. Why is the combination of tight monetary policy and wage accords a better response to an adverse external supply shock than expansionary fiscal and monetary policies? Explain by comparing the process of adjustment to the new medium run equilibrium.
Good Luck
