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 the nal 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 the scal 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 scal 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 scal decit from 2.3 to cap-
ture this kind of scal 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:

http://www.abs.gov.au/AusStats/[email protected]/MF/5206.0

http://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 scal consolidation 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 scal consolidation 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 values 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, http://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€²s 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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