Reference no: EM1350067 , Length: 2600 Words

Question 1 Economic Growth - short questions

You cannot use more than 200 words to answer each part 

1. According to the Solow growth model, there are two reasons why an increase in total factor productivity leads to an increase in output. What are those two reasons?
2. Does the fact that the income distribution between different countries in the world has not narrowed since the second world war contradict the predictions of the Solow growth model?
3. Name five factors that are likely to increase the steady state level of income in a given country.

Question 2 Inflation and the money supply.

You cannot use more than 200 words to answer each part 

1. Suppose that the money supply is under control and that the velocity of money is constant. Does this mean that inflation will be always on target?
2. Assume that the output gap is positive. According to the Taylor rule should the central bank increase or decrease the interest rate?
3. Name two mechanisms which can lead to a decrease in the velocity of money circulation. 

Question 3  Open economies

No more than 500 words

Take three historical events: the investment boom in the US in the nineties; the fiscal expansion following the German unification in 1989; the increase in savings in China in the last decades and discuss, for each example, the relation between these events and current account developments. Be sure to describe clearly the different links in the transmission mechanism.

Question 4- Fiscal Policy

No more than 500 words

Pick up a country of your choice and find data on government debt on the website of the International Monetary Fund. Explain the criteria you need to use in order to evaluate the sustainability of the debt. Define the concept of sustainability precisely and match it with the relevant data. 

Debt is sustainable if Debt/GDP not changing:

(1) Ratio rises because of interest payments r x (Debt/GDP)

(2) Ratio falls because of output growth g x (Debt/GDP)

(3) Debt increases because of primary deficit

 

Putting (1), (2) and (3) together:

                Change Debt/GDP = (r-g) Debt/GDP + Primary Deficit/GDP

                Debt sustainability (Change Debt/GDP = 0), implies:

                (r-g) Debt = Primary Surplus

                In other words the government needs to run a primary surplus to cover the excess of interest payments over GDP growth.

• To keep debt levels constant fiscal policy needs to generate primary surplus/GDP = (r-g)Debt/GDP
• If r>g government has to run a primary surplus in order to control the debt-GDP ratio
• If r<g then government can run a deficit (of a certain size) without seeing debt/GDP ratio increase
• Shifts in interest rates and growth rates have big impact on government debt dynamics
• If r increases with Debt/GDP and higher r leads to lower g then countries can rapidly find their public finances deteriorating

Debt to GDP dynamics depend on:

• the initial debt-to-GDP ratio
• the interest rate
• the growth rate of the economy

One can decrease debt by:

• generating primary surpluses (via growth usually)
• inflating debt away
• defaulting