MEcon Master of Economics Master of Economics: Introduction to Macroeconomics 5 — Questions and Answers
Question 1: Under a fixed exchange rate regime, a country that runs a persistent balance of payments deficit will eventually face:
- An unlimited accumulation of foreign exchange reserves
- Depletion of foreign reserves and potential forced devaluation (Correct answer)
- Automatic inflation that raises exports and corrects the deficit
- Rising domestic interest rates that attract sufficient capital inflows
Correct answer: Depletion of foreign reserves and potential forced devaluation
To defend a fixed rate, the central bank sells reserves; once exhausted, the peg breaks and the currency must be devalued.
Question 2: In the Mundell-Fleming model with perfect capital mobility and a floating exchange rate, fiscal expansion is:
- Fully effective because the exchange rate amplifies the stimulus
- Completely ineffective because exchange rate appreciation crowds out net exports (Correct answer)
- Partially effective with a multiplier equal to the MPC
- Effective only if accompanied by monetary accommodation
Correct answer: Completely ineffective because exchange rate appreciation crowds out net exports
Fiscal expansion raises interest rates, attracting capital inflows that appreciate the currency and reduce net exports, fully crowding out the stimulus.
Question 3: Which of the following is an example of an automatic fiscal stabilizer?
- A discretionary infrastructure spending bill passed during a recession
- Unemployment insurance payments that rise automatically when joblessness increases (Correct answer)
- The Federal Reserve cutting interest rates in response to a downturn
- A central bank purchasing Treasury securities via open-market operations
Correct answer: Unemployment insurance payments that rise automatically when joblessness increases
Unemployment insurance payments expand automatically as layoffs rise, injecting spending without requiring new legislation.
Question 4: The 'golden rule' savings rate in the Solow model is the rate at which:
- Economic growth equals population growth
- Consumption per worker is maximized in the steady state (Correct answer)
- Investment equals the depreciation rate exactly
- The marginal product of capital equals the discount rate
Correct answer: Consumption per worker is maximized in the steady state
The golden rule identifies the steady-state capital stock — and corresponding savings rate — that maximizes consumption per worker.
Question 5: Which of the following best describes the difference between nominal GDP and real GDP?
- Nominal GDP adjusts for population size; real GDP does not
- Real GDP removes the effect of price changes to reflect actual output; nominal GDP does not (Correct answer)
- Nominal GDP excludes government spending; real GDP includes it
- Real GDP is measured at current prices; nominal GDP is measured at base-year prices
Correct answer: Real GDP removes the effect of price changes to reflect actual output; nominal GDP does not
Real GDP deflates nominal values using a price index, allowing comparison of output across years without the distortion of inflation.
Question 6: The concept of 'menu costs' is used in New Keynesian economics to explain:
- Why households defer consumption when prices are expected to fall
- Why firms do not adjust prices continuously, leading to nominal price stickiness (Correct answer)
- The cost of maintaining a central bank's price stability mandate
- Why international trade is limited when transaction costs are high
Correct answer: Why firms do not adjust prices continuously, leading to nominal price stickiness
Menu costs — the literal and figurative costs of changing prices — make it rational for firms to keep prices fixed over short intervals, generating price stickiness.
Question 7: An economy experiences a positive demand shock. According to the New Keynesian model with sticky prices, the short-run and long-run outcomes are:
- Short run: higher output and prices; long run: output returns to potential with higher prices (Correct answer)
- Short run: higher output only; long run: output stays permanently above potential
- Short run: prices rise immediately to the new equilibrium; output is unchanged
- Short run: unemployment rises; long run: output falls below potential
Correct answer: Short run: higher output and prices; long run: output returns to potential with higher prices
Sticky prices allow real output to rise above potential temporarily; as prices adjust upward over time, output returns to the natural level at a higher price level.
MEcon Master of Economics Master of Economics: Introduction to Macroeconomics 5
Under a fixed exchange rate regime, a country that runs a persistent balance of payments deficit will eventually face: