Q.

1 Consider the following open economy model, where all variables except the rate of interest are
expressed in log form.

 H ,t =  Et H ,t +1 + 1 yt + 2 st −  t (1)

yt = Et yt +1 −  −1 ( it − Et H ,t +1 − st ) −  IM  −1 ( Et st +1 − st ) (2)

it = Et st +1 − st + Et H ,t +1 (3)

it =    H ,t +  y yt +  x (st − st ) (4)

TBt =  B −1 ( ( F − 1) + (1 −  B )( H − 1)) st (5)

where  =
(1 −  )(1 −  ) ;  = 0.5  (  IM
)
− 1 (1 −  ) +  ( v + 1) 
 ;  2 = 0.5 (1 −  )(1 +  )
 1−
1
  1−

 (v + 1) (1 −  )(1 + v)ln(1 −  )
 = ;

 =  F + (1 −  IM )( H − 1) − 1 ;  t = at +  ln(1 −  ) − ln(1 −  ) −
IM
1 +  IM  1− 1−

Shocks
a. st =  st −1 + ut
b.  t =  t−1 + ut

y output
H Domestic inflation
i Domestic interest rate
s ToT
TB Trade balance

Parameter Values
  H F  IM  y  x
0.75 0.99 1.5 1.5 0.40 1 0.5 1.5 0.5
   n
 im    
0.5 0.5 0.5 0.5 0.90 0.90 0.75 3
Note:- if some parameter values are not reported then you may assume your own values

Questions
(i) Calibrate the above model in case of productivity shock (  t ) and trace the trajectory of output,
inflation, and TB. Briefly explain these trajectories. Do these trajectories confirm a common
expectation from this shock? Do your results suggest that authorities may invest in productivity
of labors.
(ii) Calibrate the above model in case of ToT shock ( st ) and trace the trajectory of output, inflation,
and TB. Briefly explain these trajectories. Do these trajectories confirm a common expectation
from this shock? Do your results suggest that authorities may go for ToT deterioration
(devaluation).
Q.2 Consider the following closed economy model, where all variables except the rate of interest are
expressed in log form.

Phillips curve

πt = χEt πt +1 + γ1yt − γ3 gt − γ4 at + γ5 ktc + γ6 ktw (1)

where: -

  + v c   g   (1 − )(1 −  )
1 =   , 3 = ,  4 = (v + 1) 5 = ,  = ,  =
  c  c 1+ k c
6
1− k w 
IS curve

yt = Et yt +1 − 1(it − Et t +1 ) + 2 (Et ktc+1 − ktc ) + 4 ( gt − Et gt +1 ) + 5 (Et at +1 − at )

(2)
where:-

(1 −  )( + v) c [(1 −  )( + v)] c ( + v −  (1 + v) ) g  v(1 + v) c

1 = , 2 = 4 = , 5 =
   (1 + k )
c
 

 =  + v −  (1 + v)( + v c )

Taylor Rule

it it 1 (1 ) t (3)

Government budget constraint:

bt = 1 gt −  2 yt + 3 at −  4 ktc − 5 ktw (4)

where

 c (1 + k c ) + k w   g k w ( c + ( +  c v)) + k c c  (1 + k c ) + k w 1
1 = , 2 = , 3 = k w (1 + v) 4 = c , 5 =
c c 1+ k c
1− kw

Shocks
a. gt =  gt −1 + ut
b. ktw =  ktw−1 + ut

y output
H Domestic inflation
i Domestic interest rate
b Government budget deficit
a productivity
g Government expenditures
 kc Tax on consumption
kw Tax on wages

Parameter values
 = v = 1,  c = 0.80,  g = 0.20 ,  = 0.99  = 0.45, = 0.67, k c = k w = 0.05,  = 1.5,  = 0.75,  = 0.90

Note:- if some parameter values are not reported then you may assume your own values

Questions

(i) Calibrate the above model in case of government expenditure shock ( g t ) and trace the trajectory
of output, inflation, and government budget deficit (b) in the event of this shock. Briefly explain
these trajectories. Do these trajectories confirm a common expectation from this shock? Do
your results suggest that authorities may increase government spending to boost economy.

(ii) Calibrate the above model in case of wage tax increase ( ktw ) and trace the trajectory of output,
inflation, and government budget deficit. Briefly explain these trajectories. Do these trajectories
confirm a common expectation from this shock? Do your results suggest that authorities may
increase wage tax rate to cover government budget deficit.

(iii) Calibrate the model for an increase in government expenditures such that dbt = 0 and trace the
trajectory of output and inflation. Briefly explain these trajectories. Do these trajectories
confirm a common expectation from this shock? Do your results suggest that authorities may
follow balanced budget policy? Explain your answer with the calibrated results.