6QQMN971
Students must answer ALL questions.
Each question carries up to 50 marks.
When answering each question, start your answer on a new page of your answer book and write the number of the question.
For each question, always MOTIVATE AND DISCUSS your answer.
1. Question 1 (50 marks)
Consider the Ramsey model discussed in the lectures,
The consumer maximises lifetime utility under a feasibility constraint, given an initial value of capital k0. In each period t, the consumer has a stock of capital kt, must decide the level of consumption ct, and accumulates capital kt+1 for the following period. Condition kt+1 ≥ 0 is captured by the function
Condition kt+1 = kt is captured by function
The key steady state of the model is given by
The policy functions for consumption and next period capital are
It holds that A > 0, β 2 (0, 1) and α 2 (0, 1).
(a) Explain the economic meaning of function ˜(c)(kt ).
(b) Interpret the steady state of the model featuring zero consump- tion and positive capital. Use both math and economic thinking to explain the nature of this steady state. [NOTE: You do not strictly need to replicate a graph here]
(c) Consider two separate economies. The economies are identical except that one is impatient but productive, the other is patient but unproductive: the irst economy features β = βL , A = AH , the second economy features β = βH , A = AL , with βH > βL and AH > AL . All the remaining parameters are the same. One could guess that the two economies can enjoy the same long term level of wealth, because the less patient economy will be less likely to invest in the future, but it can also extract more output from capital, hence the two economies could share the same steady state. Use the model to verify if the two economies can reach the same steady state level and interpret your result.
(d) Does your answer to point (c) change if capital does not fully depreciate in the economy? What changes in the model if δ < 1?
Consider now a diferent economic model: a VAR model studying the response of the economy to a monetary policy shock. Suppose the variables of the model are yt = (zt , it ), with zt a potentially large vector of m variables and it the interest rate controlled by the central bank. Suppose that the equation of the structural VAR model for the interest rate is written as
(e) Explain which of the following options is correct and motivate your answer:
(I) we can conclude that the recursive identiication strategy is certainly being used to identify the monetary policy shock.
(II) we can conclude that the recursive identiication strategy is certainly not being used to identify the monetary pol- icy shock because this identiication is inconsistent with the equation provided.
(III) we cannot conclude whether the identiication strategy for the monetary policy shock is the recursive one or not because not enough information is provided, as it could still hold under the following conditions (explain which ones, in case).
2. Question 2 (50 marks)
(a) Would you expect the rate of interest to be related to the rate of growth? Please explain why?
(b) How is it possible for a high expected interest rate to be as- sociated with a weak currency as was the case for Britain in September 2022?
(c) To what extent do you think that Britain’s recent inlation is caused by over-reliance on central bank credibility?
(d) Why do banks need capital? What problems can inadequate capital give rise to?