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Homework 5
Economics 503
Foundations of Economic Analysis
Assigned: Week 5
Due: Week 6
1.
In 2005, a hurricane hit New Orleans, Louisiana, an important transportation and
oil refining center in the USA, one of Hong Kong’s key for the petrochemical
industry in that country. Consider the impact of the recent hurricanes that
devastated that city as a temporary supply shock for the USA.
a. Discuss briefly, using one graph, the outcomes that we would have been likely
to see in terms of goods markets in the USA as a result of this negative
business cycle shock.
b. Analysts are also worried that the natural disaster might have had a negative
impact on consumer confidence. Discuss briefly, using one graph, the
differences in outcomes that we would observe if this demand side effect were
stronger from the outcomes that we would observe if the supply side effects
were dominant.
2.
The U.S. Federal Reserve cuts its interest rate target.
a. Draw graphs of Hong Kong’s money market and Hong Kong’s foreign
exchange market to show the impact of this event keeping in mind that it will
be the policy of Hong Kong’s central bank to keep the exchange rate fixed.
b. Show the impact of this event on Hong Kong’s business cycle using the ASAD model.
c. Which sectors of the Hong Kong economy are likely to benefit from these
actions?
3.
In Japan, consumers become suddenly less thrifty so that savings drops and
consumption increases.
a. Show the direct impact of this on the Japanese real interest rate and
equilibrium investment using the loanable funds market model. Assume for
simplicity that Japan is a closed economy.
b. Now, consider the impact of this on the Japanese output gap and price level
using the AS-AD model.
c. Assume that the financial accelerator effect is very strong in Japan. Draw the
impact of the financial accelerator on the Japanese real interest rate and the
loanable funds market during the business cycle.
d. Could we say that real interest rates are likely to rise in a business cycle boom
driven by consumer spending? Can we say whether corporate investment is
likely to fall or rise? Explain.
4.
Does the BOJ have a Taylor Rule? The following table shows numbers for
Japan’s inflation rate, output gap, and the uncollateralized call money interest rate
for the years 1990 to 2000.
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
i.
ii.
iii.
iv.
Output
Actual Target
Gap
Inflation
Interest Rate
3.30%
3.02%
7.56%
4.09%
3.22%
7.48%
2.50%
1.70%
4.82%
0.51%
1.26%
3.18%
-0.87%
0.69%
2.41%
-1.20%
-0.12%
1.15%
2.14%
0.13%
0.48%
2.32%
1.75%
0.52%
-1.48%
0.67%
0.44%
-2.46%
-0.33%
0.06%
-2.57%
-0.71%
0.12%
Calculate the inflation gap (i.e. the difference between inflation and target
inflation) in each period if Japan had used a target inflation rate of 2% in each
year. What is the average inflation gap during the period 1990-1995
(inclusive) and for 1996-2000?
Calculate the interest target, iTGT, for every period if the Bank of Japan had
used a Taylor rule with an anchor real interest rate of 2.5% (r* = .025).
Compare this with the actual target. Does the Bank of Japan adjust the target
interest rate to domestic inflation and output?
Some have argued that the BOJ was not aggressive enough in cutting interest
rates in the early 1990’s to get the economy out of the slump. What was the
average interest rate during the period 1992-1997? What was the average
interest rate suggested by a Fed-style Taylor rule. Which was larger?
What difficulties did the Bank of Japan have in implementing the Taylor rule
in 1999 and 2000?