Assignment Paper

Section A
1. Define the following (2 marks each)
i). Involuntary unemployment
ii) Anchored inflation expectations
iii) Conditional convergence
2. How will consumer responses to a future tax rebate differ depending on the extent to which the consumer
is credit constrained? Based on your answer to this, how do you think tighter credit constraints affect the size
of business cycles?. (8 marks)
3. Assuming inflation expectations are adaptive, compare the responses of a more and less inflation averse
central bank to a temporary demand shock. Discuss how you model the degree of inflation aversion and why
some societies might be more inflation averse than others as well as the response of the bank to the shock. (8
marks)
4. Consider the long-run growth of two economies described by the Solow model. Country A is rich, has a
high level of Total Factor Productivity , and is near to its equilibrium. Country B is poor, has a low level of
Total Factor Productivity, but is growing fast compared to A. Represent this situation using the standard
Solow diagram (plot both economies on the same axis). Does the Solow model suggest that these two
countries will converge to the same income per capita? (8 marks)
Section B
5. In February 2018 the Bank of England Inflation Report said that inflation was at 3%, interest rates were at
0.5% and that interest rates were likely to rise in the future. The Bank of England is charged with maintaining
inflation at 2% on average and always within a band of 1% to 3%.
a) Represent this situation in terms of the Three Equation diagrams (5 marks)
b) Why would the Bank announce likely future increases in rates? Why not just raise the rate now? (5 marks)
c) What could happen if the Bank failed to follow through on its forecast of rising rates? (5 marks)
d) What actually happened? (5 marks)