Instructions:&You may use a hand calculator.
Answer five (5) of the eight questions in Part A.
Each question in Part A is worth eight (8) marks.
Answer four (4) of the six questions in Part B.
Each question in Part B is worth fifteen (15) marks.
Each question in Part B involves a numerical part:
be sure to show your calculations and intermediate steps.
Each question in Part B ends with an analytical part:
be sure to answer this in some detail.
Read the questions carefully.


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PART A
Answer five (5) of the following
eight questions.
Each question is worth eight (8) marks.

1. Briefly describe the effect on the overnight interest rate if
(a) Canadian banks begin to fear a bank run;
(b) the Bank of Canada makes a redeposit.

2. To reduce the unemployment rate, policymakers
may create an unanticipated inflation.  What are the costs of
an unanticipated inflation?  Alternately, policymakers may try
to reduce the natural rate of unemployment.  How might they do that?


3. Suppose that the expectations augmented Phillips curve is given by
pi = pi(e) - 0.8*(u-8.0).  If the inflation rate is 2.5 percent and the 
unemployment rate is 10 percent what must expected inflation be?
Draw a picture of the curve. What can policymakers do to reduce
pi(e) without incurring high unemployment rates?


4. Suppose that the current nominal exchange rate is 0.74 US dollars.
The one-year Canadian nominal interest rate is 6.0 percent, and the
one-year U.S. nominal interest rate is 5.0 percent.  Expected inflation
is 2.5 percent in Canada and 3.0 percent in the United States.
Given interest-rate parity, find 
(a) the expected nominal exchange rate one year from now; 
(b) the expected percentage real depreciation.


5. What combination of average and marginal tax rates most promotes 
labour supply?  Do we observe tax schedules with these features?


6. During the past twenty-five years in Canada the average wages
of women have risen relative to those of men, the unemployment rate
for women has fallen relative to that of men, and the participation
rate of women has risen relative to that of men.  Can you explain these
trends using supply-demand analysis?


7. Suppose that the federal government's primary deficit is zero.
The nominal interest rate it pays on its debt is 6.0 percent.
The debt-GDP ratio is 65 percent.
Suppose that the inflation rate over the coming year will be 2.5
percent.  Find the minimum growth rate of real GDP that
will be necessary to prevent the debt-GDP ratio from rising.


8. Comment on two proposed policies for increasing Canada's
trade balance: (a) a monetary expansion; (b) tariffs which reduce
the demand for foreign goods.  How does each policy affect the
real exchange rate?


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PART B
Answer four (4) of the following six questions.
Each question is worth fifteen (15) marks.
Each question involves a numerical part: be sure
to show your calculations and intermediate steps.  Each question
ends with an analytical part: be sure to answer this in some detail.


1.  Suppose that a small open economy can be described
by the following equations:
Y = 170 
C^d = 0.8(Y-T) - 2r
I^d = 20-8r
NX = 10 + 0.1Y_{FOR} - 20(r-r_{FOR})
M/P = 0.5Y - 0.5(r+pi^e)
where r is in percentage points.
Suppose that foreign income is given by Y_{FOR} = 200
and the foreign real interest rate is r_{FOR} = 2.
In the domestic economy G=20 and T=20.
You may assume that pi_e = 0.  The central bank
sets the money supply at M = 168.

(a) Suppose that Y = Y(bar).  What are the values of r
and P?  Draw a picture of the equilibrium.
(b) Suppose that foreign income falls to 180.  What are the
short-run ( i.e. with no change in the price level)
and long-run effects on income and interest rates?  Draw
a picture of the equilibrium.
(c)  Starting from your short-run answer in part (b) suppose
that the government sector raises spending to G=22.
What are the short-run and long-run consequences of this
policy?
(d) What are some of the obstacles to using fiscal policy for
stabilization?


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2. Imagine that components of the Canadian federal
government's budget can be described as follows:
T =110+0.3Y
TR=300-0.2Y
G=30
INT=40
Also suppose that  Y = 500.
(a) Find the budget deficit, primary deficit, and full-employment
deficit if Y=Y(bar).
(b) Find the budget deficit, primary deficit, and full-employment
deficit if Y=475.
(c) An advisor to the government proposes a cut in the lump-sum
component of federal taxes (currently 110).
What are the possible responses of provincial governments and
the private sector?  Therefore what are the likely effects
of the tax cut?

3. Some economists have suggested that Canada should fix its exchange
rate with the United States to promote trade between the two countries.
This question investigates some of the implications of such a plan for 
domestic macroeconomic policy.
Suppose that in Canada
Y(bar) = 100
C = 0.72Y
G=20
I = 20-200i
NX = 7.5-10e_{nom}
{M/P} = 0.8Y - 200i
e_{nom} = 0.75 + 10(i-i_{US}),
where i_{US} is the U.S. nominal interest rate.

(a) Suppose that initially P=1 and i_{US} = 0.06.
If the Bank of Canada fixes the nominal exchange rate at
0.75 then what must the money supply be at full employment?
(b) Suppose that the U.S. nominal interest rate rises to
0.08.  If the Bank of Canada maintains the exchange rate
at 0.75 then what happens to the domestic money supply and
domestic output in the short run?
(c) Suppose instead that the Bank announces a target range for the 
exchange rate, between 0.72 and 0.78.  Now what would you expect to
 happen to domestic output, the interest rate, and the exchange rate
in the short run when the U.S. interest rate rises to 0.08?
(Assume without calculation that the fundamental value of the exchange 
rate is below 0.72.)
(d) Are there any other policy options available which might avoid
some of these effects?


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4.
In this question, we explore the predictions
that economic theory makes for the effects of oil price shocks.
Suppose that the production function is Y = A\cdot(4N - 0.5N^2). 
Also suppose that the labour supply curve is given by
NS = 1+0.5w.

(a) Find an expression for the marginal product of labour, MPN.
Draw labour demand and supply curves.
(b) If A = 1.0, find the equilibrium real wage w, employment
N(bar), and output.
(c) If A=0.80, find the equilibrium real wage w, employment
 N(bar), and output.
(d) Use the IS-LM-FE diagram to illustrate the effect of a temporary
adverse supply shock.  What are the predicted effects on inflation
and investment?  Can monetary policy be used to stabilize the
economy after a supply shock?

5.
Suppose that in Canada the expectations-augmented inflation rate
is given by:
pi_t = pi^e_t - 0.5(u_t-\overline u)
with
\overline u = 0.08.  The subscript t counts years.
(a) Graph the long-run Phillips curve.  Graph the short-run
Phillips curve for an expected inflation rate of 0.04.
(b) Suppose that inflation expectations are given by
pi^e_t = 0.75 pi_{t-1} + 0.25 \pi_t^a
where pi_t^a is the Bank of Canada's announced target
for the inflation rate.  The current inflation rate
is pi_0 = 0.04 and the announced targets for the next three years are
pi^a_1 = 0.03, pi^a_2 = 0.015, and pi^a_3 = 0.00.
Find the unemployment rates in the next three years, assuming that
 the Bank exactly meets its targets.
(c) Given the equation for inflation expectations, does the
Bank have much credibility?
Some economists have argued that the increase in the unemployment rate
during 1991-1992 occurred because the Bank of Canada's
disinflationary targets were not credible.
Why might they have lacked credibility?
(d) Are there any other potential explanations for the
increase in the unemployment rate at that time?


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6. Imagine a small open economy, with at all times r=r_w = 0.10,
where $r_w$ is the world real interest rate.
In this economy, desired investment is given by I^d = 80-400r,
and desired saving is given by S^d = 20-G +200r where G is 
government spending. Suppose that net factor payments are zero.
(a) Suppose that G=10.  What is the country's current account balance?
(b) Imagine that there are two time periods, and that the
intertemporal external balance condition holds.
Suppose that in each time period, NX = 20-10e,
where e is the real exchange rate.
Find the values of the current and future real exchange rate.
(c) A deficit-fighting government is elected and as a result
the current value of government spending is instead G=8.
Find the effects on current and future net exports and on
the current and future real exchange rates.
(d) In general, what are the consequencs of contractionary
fiscal policy in a small open economy with a flexible exchange rate?