Fall 2007 Econ 2 Makeup Exam: Housing Crisis, Monetary Policy, and Fiscal Policy, Exams of Economics

Download Fall 2007 Econ 2 Makeup Exam: Housing Crisis, Monetary Policy, and Fiscal Policy and more Exams Economics in PDF only on Docsity! Makeup Final Exam, Econ 2, Fall 2007 NAME_________________________________________ RECITATION INSTRUCTOR_____________________ Instructions for Dr. Eudey’s Fall 2007 Econ 2 makeup final exam: • Write your answers in the space provided. • This is a 90-minute examination. You have twenty minutes for review. • Show all work. Use diagrams where appropriate and label all diagrams carefully. • Write your name and your Recitation Instructor’s name on the top of the front page of the exam. • This exam is given under the rules of Penn’s Honor system. • All exam pages, blank or filled, must be handed in at the end of this exam. No exams may be taken from the room. • The use of Programmable Calculators is in violation of Departmental rule. It is strictly forbidden. ***This is a 90-Minute Examination*** Part 1: The Housing Crisis and Recession Risk (14 points, 28 minutes) 1. (1 point, 2 minutes) What is the “newspaper definition” of a business cycle recession? (i.e the definition most commonly in-use by non-economists) Two consecutive quarters of negative growth. 2. (1 point, 2 minutes) How does an economist define a business cycle boom? If the data are above-trend (or can say if a broad set of data are above trend or can specifically say if any piece of data, such as GDP, is above-trend) 3. (3 points, 6 minutes) Explain three reasons that falling housing prices might now negatively impact U.S. Aggregate Demand. Be specific about why each factor will affect any particular Aggregate Expenditure component of AD. 1 point per reason, deduct ¼ point if answer isn’t clear about which AE component is affected. Likely answers are: There is less residential construction (part of I, so I and AD down). There is less borrowing against the value of the home to finance Consumption spending because houses are worth less and also many would-be borrowers are now unable to get loans in the risky market (C down so AD down). w/p L (w/p)* Ld L* Ls P LRAS AS1 AD1 GDP* P1 AD2 L2 w1/p2 GDP2 P2 As w falls P3 Part 2: Monetary Policy (7 points, 14 minutes) 1. (1 point, 2 minutes) Explain why an increase in the price of oil implies a decrease in MFP. Because as oil prices increase firms are forced to use less-efficient (but more fuel-efficient) means of production. 2. (2 points, 4 minutes) Write the equation for the Quantity Theory of Money (QTM). Use QTM to explain how monetary policymakers would use an MFP forecast to help them target the particular long- run inflation rate of 2%. 1 point: M2*V = P*GDP (they don’t have to define these terms) ¼ point: MFP is one of the determinants of GDP. ½ point: In order for policymakers to hit a desired inflation-target, they need to forecast MFP growth ¼ point: to make sure that M2-growth exceeds long-run GDP-growth by 2% (my answer assumes no Velocity growth but they don’t have to say that) 3. (2 points, 4 minutes) Explain the impact of a reduction in the target federal funds rate on M2. Exactly how much will M2 change? ½ point: Fed buys government securities ½ point: Dollars enter reserves of banks 1 point: Change in M2 = cost of the securities * deposit multiplier (deduct ½ point if don’t indicate that the change in initial deposits is related to how many new securities are purchased) 4. (1 point, 2 minutes) Oil prices are rising at the same time that the FOMC is now reducing its target federal funds rate. Given your answers 1, 2, and 3, defend the argument that the FOMC is foolish to be following its current course of monetary policy. ½ point: P(oil) up => MFP down => GDP down ½ point: M2 growth should slow down or inflation (above target) 5. (1 point, 2 minutes) The FOMC on Tuesday, December 11, lowered its target federal funds rate by ¼ of a percentage point. The stock market fell at the news because many had expected a ½-percentage point rate cut. Explain the stock market reaction using arbitrage theory. Interest rates now higher than expected => relative attractiveness of stocks lower than expected => demand for stocks falls (price implication obvious) Part 3: Money, Money, Money, Money! (7 points, 14 minutes) 1. (1 point, 2 minutes) What are the twin policy goals of the FOMC? ½ point: price stability ½ point: unemployment near the level implied by full employment 2. (1 point, 2 minutes) Explain how the FOMC represents a mix of public and private (business) interests. The FOMC has a mix of members approved by congress (public interest) and approved by bankers (business interests). (Or words to that effect). 3. (1 point, 2 minutes) What is the name of the current chairman of the federal reserve system? Bernanke (close sound-alikes for Bernanke are acceptable!)