FINAL EXAM: ECON2020

Fall2016
N. Aman

1) You may use your textbook and/or class notes to read and prepare for taking this exam

2) You may not discuss this exam with anyone either face-to-face nor via email nor you
may copy answers from the Internet sources. Your answers must reflect your own
knowledge in the relevant topics written in your own words. Copying any part of the
answers from the lecture notes, textbooks or Internet would be considered as the violation
of the University policy on academic honesty and integrity. Any misconduct on
plagiarism policy will turn the course into a grade of F.

It is also recommended to read my feedback to relevant weekly HW Questions.

3) The Maximum Score Points Available on this exam: 40, each portion of each question
has its potential raw score contribution as indicated.

4) Please do not send it by email. You will post your exam in the designated assignment
drop box in the blackboard (just like the way you have posted your weekly assignments
and MT exam).

5) Exam is due back before midnight (EST) on Nov 5

6) You do not have to display the questions in your answers. Just the Q #s and answers
will be fine.

7) You may also wipe out the above instructions from your answer page or do not include
them in your answer document.

8) Make sure you write down your name on the top of the page of your answer document

Maximum possible raw score = 40 points

1) Heres a quote from Fed head Janet Yellen on at a meeting in Cleveland on July
10 last year. (see www.federalreserve.gov then click news and events

Regarding inflation, as I mentioned earlier, the recent effects of lower prices for crude oil and
for imports on overall inflation are expected to wane during this year. Combined with further
tightening in labor and product markets, I expect inflation will move toward the FOMC's 2
percent objective over the next few years. Importantly, a number of different surveys indicate
that longer-term inflation expectations have remained stable even as recent readings on
inflation have fallen. If inflation expectations had not remained stable, I would be more
concerned because consumer and business expectations about inflation can become self-
fulfilling

Explain why the FOMC is concerned not only about actual recent inflation rates
as measured by the CPI, but also about longer term inflation expectations
 remaining stable In particular, what is the problem if inflation expectations
start to converge to an opinion that inflation will fall to 0 or less? 4pts

2) Suppose the CFO of an American corporation with surplus cash flow had $100
million to invest last July 15 and the corporation did not believe it would need to
utilize these funds to retool or expand production capacity for 1 year. Suppose further
that the interest rate on 1 year CD deposits in US banks was .5%, while the rate on 1
year CD deposits in England (denominated in British Pounds) was 2% at the time.
Suppose further that the exchange rate at that time was $1.68 per British pound.

A) Suppose that now a year later the exchange rate is $1.55 per US pound. What rate
of return did the CFO earn on the investment in the British CD? (Note: a specific
numeric answer is required for full credit.) 4pts.

B) What must the CFO have expected about the value of the British pound in $ today
to believe that investment in British CDs was more profitable than investment in US
CDs last July? 2pts

3) Between February 2008 and Summer 2009, the Fed supplemented its open market
operations with a greatly expanded program of direct lending (both overnight and short
term 28 and 84 day loans) to commercial banks, investment banks, brokerage and
primary dealer units of bank holding companies. It also agreed to accept a wider range of
short term securities (instead of accepting only T-Bills) as collateral on these loans and
even initiated a program to buy commercial paper from money market funds.

Explain why the Fed created all these extraordinary direct lending facilities instead of
simply relying on traditional open market purchases of Treasury securities.
4 pts

4) As conditions in short term financial markets improved by summer of 2009 the Fed
closed down its lending under these programs. However, throughout the next 4 years the
Fed increased substantially its purchases of longer term mortgage backed securities and
Treasury notes from banks in a series of 3 Quantitative Easing (QE) Programs.

A) Assume that both lender & borrower confidence levels start to return to normal and
financial and physical investment levels start to rise much more strongly in the next 12
months than in the last few years. What potential problems will the extraordinary growth
in banks reserve deposits and in the size of the Feds portfolio of longer term Treasury
and Mortgage backed bonds that has resulted from 3 rounds of Quantitative Easing create
then for the Fed? 4pts

B) What relatively untested policy tools will help the Fed deal with this problem?
Explain. ( Hint: you may wish to look at www.federalreserve.gov then click monetary
policythen Policy Normalization: principles and Plans) 4pts.
5) In recent weeks markets around the world have been rattled by signs of a slowdown in
growth of the Chinese economy, together with a massive selloff in its stock market
plus a massive default by Greece on its debts to the IMF , the ECB and on its government
bonds which will be averted only if it agrees to harsh budget austerity measures imposed
by Germany and the rest of the European UnionIn the process, the value of the $ has
risen against the Euro, the Yuan and many other currencies

A) Given the current condition of the US economy, do you think US policy makers
would prefer to see the $ rise in value, decline in value or stay at its current value?
Discuss the advantages and disadvantages to the US economy at this time of a
stronger vs. a weaker $. Frame your answer in terms of the current Aggregate
Demand and Aggregate Supply situation of the US economy. 2pts

B) How is it relevant to the events aftermath of the Brexit vote in the UK on June 23,
2016, especially in the context of trade and economy of the US with the UK in
particular, and with the EU in general? 2 pts

C) Draw an AS/AD diagram to illustrate your answers for both A) and B) above.
Clearly label axes and the current position of AS, & AD relative to full
employment RGDP.also indicate any shifts that would occur if the exchange
rate of the $ rose sharply against other major currencies 2pts.

6) Current annualized yields on 1 year US treasury securities are only .28%....while

current annualized yields on 2year US treasury securities are .69% (note you may assume
that both 1 and 2year securities in this example are 0 coupon securities with no
payment other than the maturity value on the maturity date.

What does this data suggest about financial market expectations of 1 year yields, 1 year
from now? Explain. (Assume investors are risk neutral in these short time horizons
with default free treasuries.) 4pts.

7) Each year since winning control of the House of Representatives in the 2010 election,
Tea Party Republicans have argued that we need to immediately initiate sharp reductions
in government spending and entitlement programs and rapidly move towards a balanced
budget, (although they have never actually produced a budget proposal in which tax
revenues would match government spending plus entitlement transfers). Many
Democrats, while arguing that tax rate increases on high income earners need to be part
of the any deficit reduction program, have agreed that we need to initiate budget deficit
reduction now.

A) What is the argument against attempting to balance the Federal Government budget
rapidly at the present time via either deep cuts in Federal Government spending or sharp
increases in federal income tax rates? 4pts

B) Does this argument imply that budget deficits dont matter in the long run? If not, why
might the impact of large deficits predicted in the long run under current tax and spending
programs be different than the impact today? Explain. 4pts.