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Pricniples-of-Macroeconomics-Final-Examination
ECO201 Pricniples of Macroeconomics Final Examination

1) Heres a quote from Fed head Janet Yellen on at a meeting in

Cleveland on July10 this year. (see www.federalreserve.gov then click
news and eventsRegarding inflation, as I mentioned earlier, the
recent effects of lower prices for crude oil andfor imports on overall
inflation are expected to wane during this year. Combined with
furthertightening in labor and product markets, I expect inflation will
move toward the FOMCs 2percent objective over the next few years.
Importantly, a number of different surveys indicatethat longer-term
inflation expectations have remained stable even as recent readings
oninflation have fallen. If inflation expectations had not remained
stable, I would be moreconcerned because consumer and business
expectations about inflation can become selffulfilling.
Explain why the FOMC is concerned not only about actual recent
inflation ratesas measured by the CPI, but also about longer term
inflation expectationsremaining stable In particular, what is the
problem if inflation expectationsstart to converge to an opinion that
inflation will fall to 0 or less? 4pts

2) Suppose the CFO of an American corporation with surplus cash flow

had $100million to invest last July 15 and the corporation did not
believe it would need toutilize these funds to retool or expand
production capacity for 1 year. Suppose furtherthat the interest rate on
1 year CD deposits in US banks was .5%, while the rate on 1year CD
deposits in England (denominated in British Pounds) was 2% at the
time.Suppose further that the exchange rate at that time was $1.68 per
British pound .
A) Suppose that now a year later the exchange rate is $1.55 per US
pound. What rateof return did the CFO earn on the investment in the
British CD? (Note: a specificnumeric answer is required for full credit.)
4pts.
B) What must the CFO have expected about the value of the British
pound in $ todayto believe that investment in British CDs was more
profitable than investment in USCDs last July? 2pts

3) Between February 2008 and Summer 2009, the Fed supplemented

its open marketoperations with a greatly expanded program of direct
lending (both overnight and shortterm 28 and 84 day loans) to
commercial banks, investment banks, brokerage andprimary dealer
units of bank holding companies. It also agreed to accept a wider range
ofshort term securities (instead of accepting only T-Bills) as collateral
on these loans andeven initiated a program to buy commercial paper
from money market funds.Explain why the Fed created all these
extraordinary direct lending facilities instead ofsimply relying on
traditional open market purchases of Treasury securities.4 pts

4) As conditions in short term financial markets improved by summer

of 2009 the Fedclosed down its lending under these programs.
However, throughout the next 4 years theFed increased substantially
its purchases of longer term mortgage backed securities andTreasury
notes from banks in a series of 3 Quantitative Easing (QE) Programs.
A) Assume that both lender & borrower confidence levels start to
return to normal andfinancial and physical investment levels start to
rise much more strongly in the next 12months than in the last few
years. What potential problems will the extraordinary growthin banks
reserve deposits and in the size of the Feds portfolio of longer term
Treasuryand Mortgage backed bonds that has resulted from 3 rounds
of Quantitative Easing createthen for the Fed? 4pts
B) What relatively untested policy tools will help the Fed deal with this
problem?Explain. ( Hint: you may wish to look at
www.federalreserve.gov then click monetarypolicythen Policy
Normalization: principles and Plans) 4pts.

5) In recent weeks markets around the world have been rattled by signs
of a slowdown ingrowth of the Chinese economy, together with a
massive selloff in its stock marketplus a massive default by Greece
on its debts to the IMF , the ECB and on its government bonds which
will be averted only if it agrees to harsh budget austerity measures
imposedby Germany and the rest of the European UnionIn the
process, the value of the $ hasrisen against the Euro, the Yuan and
many other currencies
A) Given the current condition of the US economy, do you think US
policy makerswould prefer to see the $ rise in value, decline in value or
stay at its current value?Discuss the advantages and disadvantages to
the US economy at this time of astronger vs. a weaker $. Frame your
answer in terms of the current AggregateDemand and Aggregate
Supply situation of the US economy. 4pts
B) Draw an AS/AD diagram to illustrate your answer. Clearly label axes
and thecurrent position of AS, & AD relative to full employment
RGDP.also indicateany shifts that would occur if the exchange rate of
the $ rose sharply against othermajor currencies 2pts.

6) Current annualized yields on 1 year US treasury securities are only

.28%.whilecurrent annualized yields on 2year US treasury securities
are .69% (note you may assumethat both 1 and 2year securities in this
example are 0 coupon securities with nopayment other than the
maturity value on the maturity date.What does this data suggest about
financial market expectations of 1 year yields, 1 yearfrom now?
Explain. (Assume investors are risk neutral in these short time
horizonswith default free treasuries.) 4pts.

7) Each year since winning control of the House of Representatives in

the 2010 election,Tea Party Republicans have argued that we need to
immediately initiate sharp reductionsin government spending and
entitlement programs and rapidly move towards a balancedbudget,
(although they have never actually produced a budget proposal in
which taxrevenues would match government spending plus entitlement
transfers). ManyDemocrats, while arguing that tax rate increases on
high income earners need to be partof the any deficit reduction
program, have agreed that we need to initiate budget deficitreduction
now.
A) What is the argument against attempting to balance the Federal
Government budgetrapidly at the present time via either deep cuts in
Federal Government spending or sharpincreases in federal income tax
rates? 4pts
B) Does this argument imply that budget deficits dont matter in the
long run? If not, whymight the impact of large deficits predicted in the
long run under current tax andspending programs be different than the
impact today? Explain. 4pts