### Applied Macroeconomics

Please read carefully

The Deadline: Each team must submit an electronic copy through Blackboard and a

hard copy to an Assignment Box (to be announced), located on the ground

oor of

the Australian School of Business building, in the West wing by 4:00pm on Monday 9

September 2013. Do not use plastic sheets or binders. Simply staple the pages together.

The name and ID of each team member should be on the cover page. The deadline

for submission for both the electronic and hard copy is Monday, 9 September 2013

4.00pm. This assignment counts for 17 percent of thenal mark. As this component of

assessment is worth less than 20%, special consideration does not apply. Submit ONE

hard copy and ONE electronic copy per team. There are penalties for submitting more

than one copy as it interferes with antiplagarism controls.

Team size: Students are encouraged (but not obliged) to self-organise into groups of 2

or 3 members each and hand in one assignment per team. The maximum size of a team

is 3 students. Assignments produced by larger teams will not be marked.

Late Submission Policy: If your team fails to submit both the electronic copy and the hard

copy by the given deadline your assignment will not be marked. Special consideration

does not apply to the late submission of the team assignment. Your team has many

weeks to complete the assignment and it is your risk if you decide to leave things to the

last few minutes to complete. This policy will be enforced to the minute.

Plagarism: All electronic copies of essays will checked for plagiarism on the Turnitin

software into which they are uploaded. See notes on Plagiarism in the Course Outline and

also note that the Turnitin software will automatically check against all other assignments

submitted (including in the past and to other institutions all over the world). Please also

note that it will be academic misconduct if the copy submitted electronically is not the

same as the copy given to your tutor. While discussing the assignments with peers is

encouraged, do not lend your assignment to another student. When an assignment is

copied, it is di cult for the instructor to determine who the copier is and your team may

be penalised heavily.

Consultation: The tutorial session ofWeek 6 will give a chance to ask clarifying questions.

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ECON 2104 – Applied Macroeconomics

MARKING GUIDE FOR TEAM ASSIGNMENT

Criteria and weighting Below expectations (F) Meets expectations (P/Cr) Exceeds expectations (D/HD)

1 Presentation: clear and precise

(20%)

• Ideas not communicated clearly,

e.g. incorrect vocabulary/ grammar

• Unprofessional presentation, little

evidence of editing (e.g. many

spelling, punctuation errors)

• Data presented poorly. Axes not

labeled, sources not reported.

Tables inaccurate.

• Ideas generally communicated

clearly although could be more

effective

• An attempt at professional

presentation and editing: only

minor spelling/ punctuation errors.

• Data generally presented well.

Some imprecision or lack of details

(e.g. missing dates, labels, axes)

• Ideas communicated clearly and

fluently; mostly accurate

vocabulary/ grammar

• Ideas expressed concisely

• Very professional presentation –

evidence of thorough editing

(negligible errors)

• Data presented professionally.

Sufficient detail (no missing dates

or label) and no irrelevant material

2 Structure: clear and well

organized (20%)

• Difficult to follow sequence of ideas;

unclear focus

• Text not clearly structured, e.g.

paragraphs not clearly developed.

• Sufficiently clear focus and

(mostly) logical sequence of ideas.

• Adequately structured

• Ideas developed logically and

coherently

• Clear focus; no irrelevant material

• Well structured

3 Critical thinking applied to

issues and ideas, and use of

theory (60%)

• Does not clearly/correctly identify or

explain issues/problem

• Little analysis or critical evaluation of

ideas or information

• Struggles to appropriately apply

theory.

• Poor handling of the data. Relates

data imprecisely to the theory

• Identifies and defines key

issues/problems but does not

convey all aspects or complexity

• Some analysis and application of

theory but with limited depth

• Good handling of the data.

• Clearly identifies and explains all

aspects of issues/problem and

conveys complexity of issue.

• Insightful analysis and critical

evaluation of ideas or information,

using appropriate theories and

showing depth of understanding

• Relates the data accurately to the

theory.

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Question 1: (10%)

Take the simple aggregate demand model we reviewed in class which assumes government

spending is exogenous (i.e. G = G). Imagine, instead, that some fraction of government

spending responds to the state of the economy. In particular, assume that G increases

if output is below potential output, Y < Y and G decreases if output exceeds potential output, Y > Y . In particular assume

G = G ?? (Y ?? Y )

so the simple model we reviewed corresponds to the special case = 0. Assume also for

simplicity that a = b = 0 and NX = 0.

1.1 Explain why in this model a rule like this can stabilise output around potential.

1.2 Why is the equilibrium level of output a function of potential output, Y ? Why is

the equilibrium level of output a function of ? Provide intuition.

1.3 Dene the scal decit as D = G ?? T. Represent graphically thecal decit as

a function of output. Compare the behaviour of the decit for two di erent values

of . Find the level of output for which the decit is zero.

1.4 Some economists argue that sal policy does not respond symmetrically to the

state of the economy. In particular, they argue that during recessions the govern-

ment increases spending by more than it decreases it during boom times. How

would you change the graphical representation of the cl decit from 2.3 to cap-

ture this kind of sa policy?

Question 2: (15%)

The simple model of aggregate demand predicts that the budget decit is countercyclical,

i.e., that it rises when output falls and falls when output rises.

Use Australian annual data to assess the validity of this prediction. Report your

ndings and conclusions.

Suggested sources:

https://www.abs.gov.au/AusStats/ABS@.nsf/MF/5206.0

https://www.budget.gov.au/2011-12/content/fbo/html/appendixb.htm

Question 3: (30%)

The following questions are based on the excel spreadsheet CGBC.xlsx which stands for

Consolidated Government Budget Constraint. CGBC.xlsx simulates the path of govern-

ment debt for di erent assumptions and starting conditions. You are meant to change

these assumptions and initial conditions and explore the implications for the dynamics

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of government debt. CGBC.xlsx is available through Blackboard. Although you may

download it as many times as you’d like, I recommend that you save a copy and name it

teamCGBC.xlsx in case you need to revert back at any time to the original. To answer

the questions you only need to change the numbers which are painted red. If you need

to go back to the benchmark values, these are in blue in Columns AD to AN.

Notice that in year 16 a sclconsolidation takes place: the growth rate of government

spending falls, the tax rate increases and the debt to GDP ratio stabilizes and then

gradually starts to fall.

3.1 Explain why the debt-to-output ratio continues to rise for a few years after the

scal consolidation has taken place.

3.2 For the baseline values the debt-to-output ratio peaks in year 33. Find the tax rate

(after year 15) such that the debt-to-output ratio peaks in year 25.

3.3 For the baseline values the debt-to-output ratio peaks in year 33. Find the growth

rate of nominal G (after year 15) such that the debt-to-output ratio peaks in year

24.

3.4 Keep the growth rate of real output at 2%. Are there parameter values such that

the primary decit-to-output ratio remains constant at its initial value of 2%? If

so, report these values and explain why they stabilise the primary decit-to-output

ratio. If not, explain why there are no values that can satisfy this condition.

Assume now that no sca onsolidation takes place in year 16. That is, set the growth

rate of nominal G (after year 15) to 6% and set the tax rate (after year 15) to 20%.

3.5 What is the debt-to-output ratio equal to in year 40?

3.6 What growth rate of real output achieves a debt-to-output ratio in year 40 equal

to that in year 1?

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Question 4: (15%)

Consider the Solow-Swan model we developed in class. The parameter values are given

in the table below:

Parameter Value

0.33

s 0.25

A 15

n 0.02

0.05

L(0) 1319

K(0) 263,800

4.1 At time 0, is the capital-labour ratio increasing, decreasing or constant? Explain

and complement your answer using diagrams.

4.2 If the economy is on its balanced-growth path by period 19, what is the level of the

capital stock in that period? And the capital-labour ratio?

4.3 Find the steady state level of income per-capita, consumption per capita and the

real interest rate.

4.4 Let s vary and plot steady state consumption per-capita as a function of s at the

values of the remaining parameters.

4.5 Find the value of s that maximises steady state consumption per capita. Comment.

Question 5: (30%)

The following questions are based on the excel spread TaylorRules.xlsx, which contains

measures of in

ation, real activity and interest rates in the Sheet called \Data” and

contains an example of a monetary policy in the Sheet called \Rules”. The policy rule,

called Rule A, is given by

rt = r + ( t ?? ) + g(gt ?? g ) (Rule A)

where r is a constant, and g are monetary policy response coe cients. In the ex-

ample t is a measure of in

ation and gt is a measure of real activity. The parametrization

of the rule is in columns B and C and in rows 1 to 9 and reproduced below

Parameter Value

r 5.3

2.5

g 3.2

1.5

g 0.5

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The Trimmed Mean serves as the measure of in

ation and GDP growth as the measure

of real activity.

5.1 At the parameter values given in TaylorRules.xlsx compute for each quarter the

di erence between the actual cash rate, robs

t and the implied policy-rule cash rate,

rt. Show a plot of the implied policy rule cash rate and the actual cash rate and

another plot of the resulting di erence, et = robs

t ?? rt, i.e the errors. Compute for

the sample the sum of the error terms, PT

t=1 et.

5.2 Set to 1:5 and g to 0:25 and nd vles for r, and g such that the sum of

the error terms is zero, PT

t=1 et = 0. Plot the new and old series for et together

and report the standard deviations of the each of two series. Comment.

5.3 Replace the trimmed mean measure of in

ation for the \all groups CPI” measure,

also known as the Headline measure of in

ation. Adjust to its sample mean

and set to 0.8 and g 0.1. What is the standard deviation of et? Plot the new

implied policy-rule-cash-rate together with that in 5.1. In the December quarter of

2000, the two rules call for very di erent levels of the cash rate. Why?

For the questions that follow, consider the following alternative rule

rt = (1 ?? )r + rt??1 + ( t ?? ) ?? u(ut ?? u ) (Rule B)

where ut stands for the rate of unemployment and t is the trimmed mean measure

of in

ation. Set the parameters to the values shown below

Parameter Value

r 5.15

2.69

u 6.52

0.80

0.50

u 0.10

5.4 Plot the implied policy rate and the actual one. What is now the standard deviation

of the error term?

5.5 For the December quarter of 2008 the average level of the cash rate was 5.3 percent

and the one implied by the rule was close to 7.8 percent. This corresponds to

biggest deviation (in absolute terms) for the in

ation-targeting sample. What was

happening in the Australian economy at the time? What do you see as potential

limitations of a Rule like B?

Suggestion: Read the Statement by Glenn Stevens, Governor of the Reserve Bank of

Australia at the time, https://www.rba.gov.au/media-releases/2008/mr-08-27.html

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5.6 The sample mean of the unemployment rate is around 6.5 percent. In part, this

sample mean is in

uenced by the early 1990′s recession but also by institutional

changes in the degree of legal regulation of the Australian labour market which has

been progressively relaxed. It is quite likely that the current steady state level of

the unemployment rate (NAIRU) is today lower than the sample mean.

Propose an alternative rule which responds in some way to the unemployment rate

but is inmune to shifts in steady state unemployment like the one described above.

Show a plot of your proposed rule (called it Rule C) and compare it with Rule B

and the actual cash rate.

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