Econ3200. Assignment 2 2023
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Econ3200. Assignment 2 2023.
Total Marks: 15
Due date: Monday, May 8th before 10 am
INSTRUCTIONS:
1. You will need to upload your answers to Blackboard.
2. You can upload multiple files in your submission, but you can only submit it once.
3. Files that can be uploaded: word, excel, pdf, jpeg, jpg, gif, png, bmp, etc.
1. Supply and Demand Shocks in the NK Economy and Interest Rate Caps. Marks:
9. Consider the following New Keynesian Economy
t = Et [t+1] - │ 、 ┌ t - Et [t+1]] + ut + ut(g) ,
t = 8Et [t+1] + t + ∈t(w) ,
t = 6π t + 6z t ,
where supply chain disruptions generate a positive cost-push shock and stimulus packages lead
to a positive demand shock, with gt = og gt一1 + ut(g), ∈t(w) = ow ∈t一(w)1 + ∈ , ut(o) t = Et ┌yˆt(f)+1] - yˆt(f) , ut(g) = (gt - Et [gt+1]) , yˆt(f) = ╱ ← gt , and = (a + o)(1一k) 一8k) . Let the economy be at
steady state in period 0, consider tan unexpected positive cost-push shock costs ∈1(o), and a positive demand shock ut(g) in period 1 (specific numbers given below), and let all other shocks be equal to 0. Note that since these shocks are unexpected, E0 [1] = E0 [1] = 0. Since oa(T) ≈ ow(T) ≈ 0 for a sufficiently big T, we assume that the shock dies off by period T = 10 and that by then the economy has already returned to its steady state. This means T = T = T = 0. Moreover, individuals correctly anticipate this ET 一1 [T ] = T and ET 一1 [T ] = T , which is also true for all periods (since there are no shocks), except for the initial expectations mentioned above. Let the parameters a = 2, o = 1, 8 = 0.90, 9 = 0.6, 6π = 1.2, 6z = 0, og = 0.7 and ow = 0.7.
(a) Let ut(g) = 0.05 and ∈1(o) = 0.10 in period 1.
i. Compute t , t , t , yˆt , t for periods 1 to 9 and briefly explain the reason behind the movements of these variables. (3 marks)
ii. Cap on interest rates. Assume that nominal interest rates only follow the Taylor rule if they are below 0.04 and otherwise fixed at 0.04. Re-compute t , t , t , yˆt , t for periods 1 to 9. Explain briefly the effect of the cap. (1.5 marks)
(b) Let ut(g) = 0.10 and ∈1(o) = 0.05 in period 1.
i. Compute t , t , t , yˆt , t for periods 1 to 9 and briefly explain the reason behind the movements of these variables. (3 marks)
ii. Cap on interest rates. Assume that nominal interest rates only follow the Taylor rule if they are below 0.04 and otherwise fixed at 0.04. Re-compute t , t , t , yˆt , t for periods 1 to 9. Explain briefly the effect of the cap. (1.5 marks)
2. Domestic Interest Rates below World Interest Rates. Marks: 4. Consider the following open New Keynesian economy
sˆt = (t(本) - Et [t(c)1]) - (t - Et [t(c)+1]) + Et [sˆt+1],
t = Et [t+1] - ╱t - Et ┌t(c)+1 ┐← - Et [∆sˆt+1] + ut ,
t(c) = 8Et ┌t(c)+1 ┐ + o t - 87Et [∆sˆt+1] + 7∆sˆt ,
where w = ai + (1 - 7)(a - 1), o = (aa + o), aa = 1一yyg = (a + o)(1一k) 一8k) , and ∆sˆt = sˆt - sˆt一1 . Suppose that world nominal interest rates increase by 5 percent, i.e. t(本) = 0.05.
Suppose the economy goes back to steady state in just one period. Let 8 = 0.90, a = 5, o = 1, i = 1, and 9 = 0.666. For an open economy with 7 = 0.5, consider two possible scenarios: (i) the interest rates at the local economy respond only slightly t = 0.025 and (ii) the interest rates increase by 5 % t = 0.05. For both scenarios, calculate t , t and t(c) . Explain your results briefly.
3. RBA Monetary Policy Decision 2nd of May 2023. Marks: 2. On Tuesday May 2nd, the RBA will need to decide its policy cash rate for May and will release a statement on the monetary policy decision.
(a) Monetary Policy Decision - May 2023. Do you think the monetary policy decision for May is the right one? Provide economic reasons to back your argument. (1 mark)
(b) Monetary Policy Decision - June 2023. Using information provided in the statement, argue whether the RBA should increase/decrease/or not change the cash rate target in the meeting of June 2022. This argument should include (i) your suggestion of increasing, lowering or not changing the cash rate policy target; and (ii) economic reasons for it that would back your suggestion. (1 mark)
2023-05-04