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Macroeconomic Policy (ECN21006) Mini Project Tasks

There are two tasks in this mini project. Each task contributes to 50% of the total mark. The summary for non-specialist should be based on your answer to Task 2. The submission deadline for all components of the Applied Portfolio will be Monday 15 May by 12.00 noon. All submissions must be uploaded to the L2 Applied Portfolio Blackboard organisation.

Task 1 A Problem Set on Monetary Policy

Please answer ALL the questions in this problem set.

The distribution of marks across components: a) 30%, b) 50%, c) 20%.

In a financial crisis, the bankruptcy of a commercial bank reduces consumer confidence (causes a shift of the IS curve). Households and banks reduce their levels of indebtedness as a process of ‘repairing their balance sheets’. As a consequence, aggregate demand becomes less responsive to an interest rate cut.

This question uses the Carlin and Soskice Macroeconomic Simulator available from the unit Blackboard. Start by opening the simulator and choosing the closed economy version. Then reset all shocks by clicking the appropriate button on the left hand side of the main page. Use the simulator to work through the following:

1) Apply a permanent 2% negative demand shock.

2) Set the size of risk premium at 1%.

3) Set the stabilizing real interest rate at 2%.

4) Set the degree of inflation inertia at 0.8 (i.e., ).

5) Set the sensitivity of expenditure w.r.t interest rate at 1. Save your data.

a) Plot the impulse response functions from the simulator to show how inflation, output and interest rate respond to a permanent 2% negative demand shock. Explain the path of the economy following the shock.

b) What happens to your result if you set the sensitivity of expenditure w.r.t interest rate at 2? Use the 3-equation model to explain how the central bank stabilises the economy.

c) Compare a) with b) and explain what causes the deflation trap.

Your answers to these questions should be no more than three pages.

Task 2 Briefing Note

Imagine you are working as an economic analyst in the Civil Service (or in a consulting firm) and higher-up officials (or your client) asked for your help; they want you to write a briefing note to explain to them if and how the fiscal policy response to the COVID-19 pandemic in the UK differed from the response of a given other country.

For the purpose of this assessment, you are free to choose the other country to be compared to the UK. Assume that the intended readers of your briefing note are already familiar with the technical terms and concepts studied in this module.

Your work will be judged on the following criteria:

- Quality of your data analysis. Your work must be based on the analysis of data from reliable sources, for instance from the IMF's Government Finance Database as demonstrated in the first workshop on fiscal policy.

- General accuracy and rigour. It is not necessary to remind your readers of the definition of each term you employ. However, it must be clear from the context that you precisely understand the meaning of all these terms and concepts and use them advisedly.

- Demonstration of specialist knowledge. Your analysis must be finer than that of a general-interest newspaper for instance. Use the concepts introduced in the lectures.

The briefing note should be two-page long. The list of references should be provided below the note, on a third page.

It should be structured in four sections:

1. In first place: a summary of your most important findings - what you absolutely want readers to remember (bullet point are appropriate, this section is the shortest).

2. A section with further details about the relevant aspects of the UK fiscal response.

3. A section with further details about the response of the second country you chose. Sections 2 and 3 form the core of your briefing note.

4. A final short section with your personal critical comments. For instance, you could explain if the differences you found between the two responses could be explained by specific constraints that applied only to one country (assuming you found differences). Or do you think policy makers made a mistake, were too fast or slow ? Could UK policy makers learn from the experience of the other country, or is it too different ?