HO JUN LIM

1046621

Assignment #3

Avenue Drop Box

11:59 PM Friday June 12, 2015

Question#1: (10 marks)

(a)
Consider a three-year bond, which entitles the owner of this bond $100 per year.
If the interest rate is 10 percent, the present value of bond = $248.69
(b)
Consider a perpetuity bond, which entitles the owner of this bond $100 per year.
If the interest rate is 10 percent, the present value of bond = $1000
Question#2: (30 marks)
(a)
Suppose the leakage rate is 0.4 and the marginal propensity to consume is 0.8.
Find the following multiplier estimates. (20 marks)
(i)
Government expenditure multiplier = 2.5
(ii)
Tax-multiplier = 2
(iii)
If government spending (G) increases by 100, then Y will increase by =
250
(iv)
If lump sum tax (T) decreases by 100, then Y will increase by = 200
(b)
Provide 4 reasons why actual government multipliers can be lower than the
multiplier estimates in the previous question.(10 marks)
1.
actual multiplier may be lower due to crowding out effect, which depends
on the interest sensitivity of investmnet
2.inflation and uncertainty can also dampen the multiplier value
3. higher value of domestic currency can also dampen the multiplier value
4. if consumers are forward looking and expect higher taxes from government in
future. Then spending propensity will go down and as a result, multiplier will be
lower than the textbook multiplier
Question #3: (60 marks)
Each of the following answers should not more than one page.
Half-a-page answer for each part is ok.
(a)

Summarize the views held by Jeffrey Sachs.

Neo Keynesians : aggregate demand management. The view is based on five

assumptions. Economic policy making is left to individual countries. Focus on price
stability, low unemployment and high growth. Manage key macroeconomic variables as
the way to achieve price stability and high growth. Issues of income distriutions are
peripheral and not relevant to growth and inflation. Structural issues have little
macroeconomic significance.
(b)

Summarize the views held by Joseph Stiglitz regarding macroeconomic issues.

The most remarkable aspect is the consensus that the macroeconomic models that
had been relied upon in the past had failed. The standard models said bubbles could not
exist and that market is efficient. The crisis was manmade. While in standard models,
shocks were exogenous, here, they were endogenous.

HO JUN LIM
1046621

The ultimate objective of a central bank is to stabilize the real economy and both
financial and price stability need to be seen as instruments toward this and other ultimate
objectives.
Inflation had been a serious problem in the past, so in focusing on other
variables, it was important not to lose sight of the risks which high and variable
inflation can impose : self regulation clearly failed, but it can still be part of an
overall regulatory scheme, capital flows bring benefits, and these should not be lost
sight of.
(c)

Summarize the views held by Ben Bernanke

Ben Bernanke belied in secular stagnation hypothesis : depressed investment and
consumption spending will prevent the economy from reaching potential output
He believed that the reason for slow recovery was the restrictive fiscal policy that
US government was implementing. State and local government budgets have been highly
contractionary, reflecting the declining tax revenues. The tight fiscal policy have likely
been counter productive, and with the fiscal and monetary policy working in different
consumption, recovery is weaker than it otherwise would be. Bernanke suggests that
monetary policy has less room to manuever when interest rates are close to zero, while
expansionary fiscal policy is likely to be both more effective and less costly when interest
rates are at low levels. He believed in balanced policy mix would avoid some of the costs
of low interest rates financial stability, sacrificing jobs and growth.