Applied Macroeconomics LAST

APPLIED
MACROECONOMICS
A TEXTBOOK
OLENA V. BAZHENOVA
Kyiv
KARAVELA
2020
УДК 33:[330.3+338]
Approved at the meeting of the Academic Council of the Faculty of Economics,

Taras Shevchenko National University of Kyiv
(minutes №2 of September 29, 2020)
Reviewers:
Varnalii Zaharii S., Professor, Department of Finance, Faculty of
Economics, Taras Shevchenko National University of Kyiv
Korchynska Olena A., Head, Department of Marketing, Academy of
Labour, Social Relations and Tourism
Bazhenova Olena V.
Applied Macroeconomics : A textbook / Olena V. Bazhenova.
Kyiv, Karavela, 2020. 92 p.
The textbook covers theoretical backgrounds, tests, problems

and computer exercises on macroeconomics. The problems are
illustrated by macroeconomic statistics of a number of countries
worldwide.
For students, PhD students and lecturers on macroeconomics,
as well as a wide range of researchers interested in macroeconomic
analysis.
APPLIED MACROECONOMICS
CONTENTS
CHAPTER 1. INTRODUCTION ............................................................... 5

1.1. Background ....................................................................................... 6
1.2. Tests ..................................................................................................... 8
1.3. Problems ......................................................................................... 11
1.4. Suggested reading ....................................................................... 14
CHAPTER 2. PRIVATE SECTOR DEMAND ..................................15

2.1. Background .................................................................................... 15
2.2. Tests .................................................................................................. 18
2.3. Problems ......................................................................................... 23
2.4. Computer exercises .................................................................... 27
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OLENA V. BAZHENOVA
CHAPTER 3. LABOUR MARKETS ..................................................31

3.1. Background .................................................................................... 31
3.2. Tests .................................................................................................. 33
3.3. Problems ......................................................................................... 36
CHAPTER 4. ECONOMIC GROWTH .................................................. 43

4.1. Background .................................................................................... 44
4.2. Tests .................................................................................................. 46
4.3. Problems ......................................................................................... 51
CHAPTER 5. INFLATION AND BUSINESS CYCLES ..................... 58

5.1. Background .................................................................................... 58
5.2. Tests .................................................................................................. 61
5.3. Problems ......................................................................................... 67
CHAPTER 6. MACROECONOMIC POLICY ...................................... 74

6.1. Background .................................................................................... 74
6.2. Tests .................................................................................................. 76
6.3. Problems ......................................................................................... 83
4
CHAPTER 1
INTRODUCTION
Keywords
gross domestic product (GDP) balance of payments
gross national income (GNI) current account
final products capital account
absorption financial account
public expenditure on goods
exchange rate
and services
GDP-deflator depreciation / appreciation
consumer price index (CPI) devaluation / revaluation
net exports the Marshall-Lerner’s condition
information asymmetry dichotomy
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OLENA V. BAZHENOVA
1.1. Background
Gross domestic product (GDP) is the market value

of final goods and services produced in the country in a
given period.
Gross national income (GNI) is the sum of value
added by all residents, any product taxes (less subsidies) not
included in the valuation of output, and net receipts of
primary income (compensation of employees and property
income) from abroad.
Final products are goods and services purchased for
final use and not for resale, further processing or
reprocessing.
Absorption is the total national (private and public)
expenditure on goods and services.
Public expenditure on goods and services is all the
public expenditures on final products of enterprises and all
direct purchases of resources.
Savings is a part of total income that remains after
consumer spending.
Net exports (NX) is the difference between exports
and imports of goods and services.
The GDP deflator is the ratio of nominal GDP to the
real one.
The Consumer Price Index (CPI) measures the cost
of purchasing a fixed set of goods and services (consumer
basket).
All agreements of residents of the country with the rest
of the world are presented in the balance of payments. It
6
includes three main sections: current account, capital

account and financial account.
The current account represents trade in goods and
services and transfer payments.
The capital account represents the purchase and sale
of assets.
A positive balance of payments means that there is
an excess supply of foreign currency because country
receives more currency than necessary for international
payments (balance of payments surplus).
A negative balance of payments means that there is
an excess demand for foreign currency (balance of payments
deficit).
Depreciation / appreciation is a change in the value
of foreign currency in a floating exchange rate regime. The
national currency depreciates if its value denominated in
foreign currency decreases. An appreciation is an increase of
a currency value in relation to other currencies.
Devaluation is a change in the exchange rate in a fixed
exchange rate if the price of foreign currency increases.
Revaluation is a change in the exchange rate in a fixed
exchange rate if the price of foreign currency decreases, and
the domestic currency rises.
The Marshall-Lerner condition states that a growth
of net exports with an increase in the real exchange rate
dominates the effect of increasing the value of imports.
The foreign currency exchange rate is the value of
foreign currency expressed in units of domestic one.
Information asymmetry is a condition under which
one party has better information than the other (others).
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OLENA V. BAZHENOVA
The dichotomy is the principle by which physical and

monetary sectors of an economy are independent.
1.2. Tests
1.2.1. Gross domestic product is
a) the sum of all manufactured goods and services;
b) the amount of goods and services sold;
c) the total market value of final goods and services
produced during the year by residents of the country;
d) the total market value of final goods and services
produced during the year by residents and non-
residents of the country.
1.2.2. Macroeconomics examines economic processes at the

level of
a) enterprises;
b) industries;
c) a separate market;
d) national economy.
1.2.3. Сalculation of GDP does not take into account

a) resale of goods;
b) public and private transfer payments;
c) securities transactions;
d) all answers are correct.
1.2.4. Equilibrium in the economy is achieved if
8
a) the sum of planned and unplanned investments is

equal to savings;
b) unplanned investments are zero;
c) investment equals savings;
d) correct answers are (b) and (c).
1.2.5. Nominal GNP is the value of goods and services

measured in
a) current market prices;
b) prices of a base year;
c) fixed prices;
d) wholesale prices for products.
1.2.6. The most appropriate metric for measuring an annual

change in the physical volume of production is
a) GDP deflator;
b) real GDP;
c) nominal GDP;
d) consumer price index.
1.2.7. GDP is a macroeconomic indicator that reflects the

market value of all final goods and services
a) produced in the economy;
b) produced on the territory of a given country and
abroad;
c) produced on the territory of the state regardless of
nationality;
d) the country has produced for a certain period and
consumed in all sectors of its national economy.
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OLENA V. BAZHENOVA
1.2.8. GDP and GNI differ by

a) the cost of the intermediate products;
b) the balance of factor income from abroad;
c) transfer payments;
d) deflator.
1.2.9. Indicate which indicator is equal to the sum of net

national product and depreciation charges
a) gross national product
b) added value
c) personal income
d) national income
e) none of the above
1.2.10. During inflation

a) real GDP is growing at the same rate as nominal GDP;
b) nominal GDP is not growing as fast as real;
c) nominal GDP is growing faster than the real one;
d) it is impossible to give a clear answer over the ratio of
the dynamics of real and nominal GDP.
1.2.11. If the GDP deflator rose while real GDP was

shrinking, what would happen to nominal GDP?
a) it would also grow;
b) it would also be reduced;
c) it would remain unchanged;
d) it could neither decrease nor increase or remain at the
same level.
10
1.2.12. The GDP / GNI of which country will include profit

of a Ukrainian joint-stock company (operating on the
territory of Ukraine) owned by a Swedish citizen
a) Swedish GDP / GNI of Ukraine;
b) GDP of Ukraine / GNI of Sweden;
c) GDP of Ukraine / GNI of Switzerland;
d) there are no correct answers;
e) it depends on the opinion of the evaluating authority.
1.3. Problems
1.3.1. The exchange rate of the Mexican peso to the dollar

in 1970 was 10 pesos per dollar. The price index in 1986 in
the US was 282, and in Mexico - 9138 (1970 = 100%). What
was the exchange rate of the peso to the dollar in 1986,
calculated on a PPP basis (1986 nominal exchange rate)?
1.3.2. A Big Mac in the US costs $ 4.33, in Sweden - 65 SEK.

The current exchange rate is 9.09 kroons to one dollar.
Determine whether the krone is undervalued or overvalued
against the dollar compared to the PPP rate.
1.3.3. How will the following transactions affect Germany's

balance of payments:
a) a German citizen bought a Renault car made in France
b) a German citizen bought a house in Italy
c) a German citizen living in Italy buys a house in Italy
d) the US banker sends his daughter a transfer in dollars
to Berlin
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OLENA V. BAZHENOVA
e) the US banker sends money to his bank account in

Munich
f) a worker from Tunisia in Munich sends money to his
family in Tunisia
g) Volkswagen, a German concern, pays dividends to a
Swedish citizen
h) the profits of the US company are reinvested in the
expansion of the production capacity of the factory in
Hamburg (Germany)
1.3.4. Analyse data from the balance of payments in Poland

in 2018 and 2019 presented in Table 1.1.
What are the key parts of capital and financial accounts?
What causes such flows of capital and finance?
Table 1.1. Current, capital and financial accounts balances

in Poland
2018 2019
Current Account, Total, Net -5820 2448
Goods and Services 19945 30865
Primary Income -24103 -26372
Secondary Income -1662 -2045
Capital Account, Total, Net 12148 11803
Financial Account, Net lending (+) /
Net borrowing (-) 1898 7510
Source: IMF
1.3.5. Table 1.2 concerns data on GNI (formerly GNP) as

the sum of value added by all residents, any product taxes
12
(fewer subsidies) not included in the valuation of output and

net receipts of primary income (compensation of employees
and property income) from abroad. Besides this, it contains
data on GDP at purchaser's prices as the sum of gross value
added by all residents in the economy plus any product taxes
and minus any subsidies not included in the value of the
products. Data is in current bil. U.S. dollars.
Table 1.2. GDP and GNI in 2019 (in current bil. $)

GNI/GDP
Country GDP GNI Ratio
Canada 1736.43 1718.55 -1.03
Denmark 348.08 357.27 2.64
Germany 3845.63 3957.76 2.92
Italy 2001.24 2018.38 0.86
Japan 5081.77 5263.54 3.58
Kuwait1 140.65 162.55 15.58
Norway 403.34 420.12 4.16
Singapore 372.06 337.73 -9.23
Switzerland 703.08 716.96 1.97
Ukraine 153.78 158.53 3.09
United
Kingdom 2827.11 2788.38 -1.37
United States 21374.42 21625.00 1.17
Source: World Bank
What are the causes of differences between GDP and GNI

in each country?
1
Data for 2018
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OLENA V. BAZHENOVA
1.4. Suggested reading
Required
Bazylevych, Viktor, Bazylevych, Kateryna, Balastryk,
Larysa. 2008. Macroeconomics: Textbook. Edited by Viktor
Bazylevych. 4th edition. Kyiv: Znannya.
Burda, Michael, Wyplosh, Charles. 2012.
Macroeconomics: A European Text. Oxford: Oxford
University Press.
Romer, David. 2012. Advanced Macroeconomics.
McGraw-Hill.
14
CHAPTER 2
PRIVATE SECTOR DEMAND
Keywords
consumption national savings
permanent income national income
life-cycle hypothesis Dutch disease
permanent income hypothesis Tobin’s q
consumption alignment investment accelerator
national investment primary current account
2.1. Background
Investment is referred to as a supplement to the

physical stock of capital.
Investment subsidies are tax benefits associated with
investment expenditures.
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OLENA V. BAZHENOVA
Household consumption expenditures are

household expenditures on goods and services, including
durable goods.
The marginal propensity to savings is a value
inversely proportional to the value of the multiplier.
The budget constraint is the constraint in terms of
future value as the current values of revenue and
expenditure are adjusted for the interest they may yield in
the next period.
Accelerator characterizes the positive impact of GDP
increase on investments.
Autarky means the state of a country in which it does
not maintain economic ties with other countries.
The choice between consumption and leisure is a
fundamental determinant of labour supply decisions as
income and work are needed to sustain consumption that
means decrease in leisure time.
The hypothesis of rational expectations means the
consumer bases his ideas about the future on some model
of behaviour taking into account all available information at
the moment.
The Tobin’s q is the ratio of the market value of the
firm to value of its capital stock. It is an indicator of the
company's performance and return on investment.
Excessive smoothing of consumption is a weak
reaction of consumption to unexpected changes in income.
Hypersensitivity is the presence of a strong reaction
of consumption to past changes in income.
Consumption paradox is the difference in the
behaviour of consumer spending in the short and long term.
16
Permanent income is the averaged life cycle income.

Permanent income for a given income flow is a
permanent income the net present value of which is equal to
the net present value of the actual income flow.
Life cycle theory is a theory according to which the
consumer plans his/her consumption expenditures that are
the same over the expected life period. Individuals save
during employment period and spend savings at retirement
age.
The theory of permanent income means the
consumption is determined not by current but by permanent
income.
Interest rate means the cost associated with keeping
a person's financial resources in the form of money.
The Barro-Ricardo equivalence is the hypothesis
according to which time to finance a certain flow of
government spending does not affect the time-limited
budget constraints of economic agents and, therefore,
decisions regarding actual spending and savings.
The multiplier effect means that in case of
autonomous expenditure changes output will increase by an
amount greater than the initial change in expenditures.
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OLENA V. BAZHENOVA
2.2. Tests
2.2.1. If the consumer behaves as a borrower in the model

of permanent income, then an increase in interest rates
causes
a) reduction of consumption and growth of savings in
the first period;
b) reduction of savings and growth of consumption in
the first period;
c) reduction of consumption and savings in the first
period;
d) growth of consumption and savings in the first period.
2.2.2. According to the theory of permanent income an

increase in current income in the first period causes
a) increase of consumption and savings in the first
period;
b) increase of consumption and savings in the second
period;
c) increase of consumption in the first and second
periods;
d) there are no correct answers.
2.2.3. According to the permanent income hypothesis

savings will decrease, and
a) current income will rise;
b) temporary income will grow;
c) permanent income will decrease;
d) interest rate will fall.
18
2.2.4. With the growth of income tax consumption of

current and future periods
a) will fall;
b) consumption will decline only in the current period;
c) the direction of change is not defined because it
depends on the size of the interest rate;
d) the direction of change is not defined because it
depends on whether it is possible to consider
consumption in current and future periods as
substitutes.
2.2.5. According to the life cycle hypothesis, the

consumption function C  0,025W  0,5Y means that
a) a person expects to live 40 years (from the beginning
of the working period);
b) the retirement period will be half of life expectancy
(from the beginning of the working period);
c) with an increase in wealth by one dollar consumption
will increase by 2.5 cents;
d) all of the above is true.
2.2.6. According to the life cycle hypothesis, a person who

plans to work for 40 years and live for 50 years (from the
beginning of the working period) will have a consumption
function
a) C  0,2W  0,6Y ;
b) C  0,2W  0,8Y ;
c) C  0,04W  0,8Y ;
d) C  0,02W  0,8Y ;
e) all answers are correct.
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OLENA V. BAZHENOVA
2.2.7. Which of the following statements are true:

a) researches show that high-income households have a
lower average propensity to consume than low-
income households;
b) the average propensity to consume is constant in the
long run;
c) life cycle and permanent income hypotheses can
explain most of the empirical data on average
propensity to consume.
2.2.8. When the price level in the economy increases, the

Tobin’s q coefficient
a) increases;
b) decreases;
c) does not change;
d) the answer depends on the value of the coefficient
(more than 1, less than 1).
2.2.9. If the depreciation rate increases, then the real wealth

of the household, the owner of the shares of the firm
a) falls;
b) is growing;
c) remains unchanged;
d) the depreciation rate does not affect the wealth of the
household.
2.2.10. The growth of a stock of capital will affect the

equilibrium level of real wage in such way
a) will increase;
b) will reduce;
c) will not change;
20
d) it is impossible to say for sure.
2.2.11. A rise of interest rate in the model of loan financing

of investments (the firm is a corporation)
a) increases the dividend income of households;
b) reduces the dividend income of households;
c) dividend income of households remains initial;
d) can both increase and decrease the dividend income
of households.
2.2.12. A rise in nominal wages leads to (in case of perfect

competition)
a) an increase of Tobin’s q;
b) a reduction of Tobin’s q;
c) Tobin’s q ratio remains unchanged;
d) it is impossible to say surely.
2.2.13. A rise of the company's share price causes

a) growth of the Tobin’s q;
b) reduction of the Tobin’s q;
c) will not affect the Tobin’s q;
d) the answer depends on the value of the Tobin’s q
(more than 1, less than 1).
2.2.14. Payment of capital taxes causes

a) reducing of the demand for gross and net
investment;
b) growth of the demand for gross and net investment;
c) reduction of the demand for net investment (impact
is not defined for gross investment);
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OLENA V. BAZHENOVA
d) growth of the demand for gross investment (impact

is not defined for net investment).
2.2.15. A decrease in interest rates causes

a) growth of Tobin’s q;
b) reduction of Tobin’s q;
c) will not affect Tobin’s q;
d) the answer depends on the value of Tobin’s q (more
than 1, less than 1).
2.2.16. An increase in the company's profit causes

a) growth of Tobin’s q;
b) reduction of Tobin’s q;
c) will not affect Tobin’s q;
d) the answer depends on the value of Tobin’s q (more
than 1, less than 1).
2.2.17. Assume that in the flexible accelerator model, the

adjustment factor λ equals 0.4; the expected stock of capital
is 6, existing stock of capital is 5 and depreciation rate is
10%. What will be the net investment in the first year?
a) 1;
b) 0.45;
c) 0.5;
d) 0.4.
22
2.3. Problems
2.3.1. The data below concerns several macroeconomic

indicators of such oil-imported countries as Russian
Federation, Qatar, Saudi Arabia, and Nigeria (Tables 2.1-2.4)
as well as basic oil indexes (Figure 2.1).
Analyse the impact of oil prices fluctuations on economies
of such oil-imported countries as Russian Federation, Qatar,
Saudi Arabia, and Nigeria.
Is data sufficient to examine the Dutch Disease
phenomenon in these countries? If needed, use additional
data to prove / disprove it.
2016=100
Figure 2.1. Oil price indexes in 2013-2019

Source: IMF
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OLENA V. BAZHENOVA
Table 2.1. Macroeconomic indicators of the Russian

Federation’s economy
2013 2014 2015 2016 2017 2018
Final consumption expenditure
4.10 0.90 -7.89 -1.04 3.10 1.79
(annual % growth)
GDP growth (annual %) 1.80 0.70 -2.31 0.33 1.63 2.25
GDP per capita growth (annual
1.58 -1.08 -2.52 0.15 1.52 2.26
%)
Gross fixed capital formation
1.30 -1.80 -10.66 1.02 5.21 2.87
(annual % growth)
Gross national expenditure (%
94.61 93.98 92.48 94.91 94.85 89.48
of GDP)
Gross savings (% of GDP) 24.65 24.94 26.72 25.37 26.01 30.19
Current account balance (% of
1.46 2.79 4.97 1.91 2.05 6.84
GDP)
Households and NPISHs Final
consumption expenditure per 4.93 0.18 -9.52 -2.07 3.20 2.31
capita growth (annual %)
Source: World Bank
Table 2.2. Macroeconomic indicators of Qatar’s economy

2013 2014 2015 2016 2017 2018
15.97 8.44 4.49 -1.68 -0.23 -
(annual % growth)
GDP growth (annual %) 4.41 3.98 3.66 2.13 1.58 1.49
-1.87 -1.21 -0.65 -1.28 -1.04 -0.58
%)
Gross national expenditure (% of
56.95 63.04 79.58 94.12 86.21 80.80
GDP)
30.42 23.96 8.50 -5.45 3.85 8.70
GDP)
consumption expenditure per 2.27 2.63 3.40 3.17 1.75 -
Source: World Bank
24
Table 2.3. Macroeconomic indicators of Saudi Arabia’s

economy
2013 2014 2015 2016 2017 2018
(annual % growth) 6.46 8.65 3.01 -6.85 3.25 3.42
GDP growth (annual %) 2.70 3.65 4.11 1.67 -0.74 2.43
%) -0.37 0.75 1.48 -0.60 -2.71 0.61
(annual % growth) 5.61 7.49 3.70 -14.04 0.70 -2.98
of GDP) 78.87 86.89 105.43 99.57 94.49 86.76
GDP) 18.14 9.75 -8.67 -3.70 1.52 8.98
consumption expenditure per
capita growth (annual %) 0.13 3.17 4.07 -1.34 1.18 0.08
Source: World Bank
Table 2.4. Macroeconomic indicators of Nigeria’s economy

2013 2014 2015 2016 2017 2018
Final consumption
17.24 -0.10 -0.33 -5.87 -1.44 7.03
expenditure (annual % growth)
GDP growth (annual %) 6.67 6.31 2.65 -1.62 0.81 1.94
GDP per capita growth
3.85 3.51 -0.03 -4.17 -1.79 -0.67
(annual %)
7.86 13.43 0.61 -6.67 -2.98 9.74
(annual % growth)
96.08 95.23 101.22 102.29 100.00 101.99
of GDP)
3.70 0.16 -3.12 0.67 2.77 1.34
GDP)
consumption expenditure per 17.87 -2.03 -2.92 -6.54 -3.50 2.53
Source: World Bank
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OLENA V. BAZHENOVA
2.3.2. The data below regards gross capital formation and

savings in Germany and Madagascar both in billion dollars
and percent of GDP in 2014-2017.
Table 2.5. Gross capital formation and savings in Germany
and Madagascar
2014 2015 2016 2017
Gross capital formation (bil. $) 791 672 701 759
Germany
Gross capital formation (% of GDP) 20,4 20,0 20,2 20,7

Gross domestic savings (bil. $) 1048 926 956 1018
Gross domestic savings (% of GDP) 27,0 27,6 27,6 27,8
Gross capital formation (bil.$) 2,1 1,8 1,9 2,1
Madagas-
Gross capital formation (% of GDP) 16,5 16,0 16,4 15,8

car
Gross domestic savings (bil.$) 1,4 1,3 1,6 1,6

Gross domestic savings (% of GDP) 11,1 11,6 13,7 12,3
Source: World Bank
Comment on the reasons of differences between gross
domestic savings in Germany and Madagascar based on the
life cycle theory.
2.3.3. Analyse sources of investments funding in Poland in

1998-2006 based on the data below.
Table 2.6. Macroeconomic indicators of Poland’s economy
1998 1999 2000 2001 2002 2003 2004 2005 2006
Gross capital formation
25,2 25,5 24,6 20,6 18,4 18,8 20,2 19,9 21,7
(% of GDP)
Gross savings (% of
21,5 20,4 18,6 17,4 15,7 16,3 14,6 17,2 17,7
GDP)
Households and
NPISHs Final
consumption 4,9 5,5 2,9 2,0 3,9 1,6 4,2 1,8 4,8
expenditure (annual %
growth)
Current account balance
-4,0 -7,4 -6,0 -3,1 -2,8 -2,5 -5,4 -2,6 -4,0
(% of GDP)
GDP growth (annual %) 4,6 4,6 4,6 1,2 2,0 3,6 5,1 3,5 6,2
Source: World Bank
26
2.4. Computer Exercises
2.4.1. The table 2.7 contains data on the US GNI and

households and NPISHs final consumption expenditure (in
constant 2010 bil.US$).
Examine the relationship between these indicators based on
estimation of such static and dynamic regressions:
 linear model
Сt    INCt   t
 log-linear model
ln Сt     ln INCt   t
 distributed lag model
ln Сt    0 ln INCt  1 ln INCt 1  ...
  p ln INCt  p   t
 autoregressive distributed lag model

ln Сt    0 ln INCt  1 ln INCt 1  ...
  p ln INCt  p   1 ln Ct 1  ...   m ln Ct  m   t
.
Choose the model that fits the best way.

Interpret the estimates.
Calculate dynamic effects of increased GNI on households
and NPISHs final consumption expenditure.
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OLENA V. BAZHENOVA
Table 2.7. GNI and Households and NPISHs Final

consumption expenditure in the US, 1970-2017
Households and Households and
NPISHs Final NPISHs Final
Year GNI Year GNI
consumption consumption
expenditure expenditure
1970 4769,1 2954,3 1994 9942,2 6424,3
1971 4929,0 3067,1 1995 10214,1 6613,8
1972 5189,0 3255,0 1996 10601,2 6843,3
1973 5493,7 3416,0 1997 11060,6 7101,0
1974 5470,1 3387,4 1998 11547,2 7478,2
1975 5446,6 3464,2 1999 12104,8 7872,1
1976 5747,2 3657,3 2000 12613,8 8272,1
1977 6017,0 3811,9 2001 12755,0 8480,5
1978 6346,2 3978,7 2002 12971,2 8698,3
1979 6566,0 4073,3 2003 13354,9 8974,7
1980 6547,4 4060,6 2004 13880,0 9311,4
1981 6702,3 4116,9 2005 14361,4 9643,1
1982 6586,5 4177,1 2006 14737,5 9938,5
1983 6883,7 4413,6 2007 15071,6 10159,4
1984 7372,5 4645,8 2008 15093,5 10137,8
1985 7656,4 4886,3 2009 14702,5 10010,7
1986 7904,7 5088,0 2010 15126,7 10185,8
1987 8177,3 5260,8 2011 15392,9 10378,1
1988 8525,0 5480,6 2012 15726,2 10534,0
1989 8838,6 5640,4 2013 16007,3 10687,2
1990 9018,0 5754,0 2014 16400,5 11003,6
1991 9002,3 5764,3 2015 16850,8 11409,2
1992 9316,0 5976,5 2016 17104,4 11721,4
1993 9570,3 6184,7 2017 17498,0 12027,2
Source: World Bank
28
Required
Bazylevych, Viktor, Bazylevych, Kateryna, and
Balastryk, Larysa. 2008. Macroeconomics: Textbook. Edited
by Viktor Bazylevych. 4th edition. Kyiv: Znannya.
University press.
McGraw-Hill.
Recommended
Friedman, Milton. 1957. A Theory of the
Consumption Function. Princeton, NJ: Princeton
University Press.
Fuhrer, Jeffrey C. 2000. “Habit Formation in
Consumption and Its Implications for Monetary-Policy
Models.” American Economic Review 90 (June): 367–390.
Hall, Robert E. 1978. “Stochastic Implications of the
Life Cycle-Permanent Income Hypothesis: Theory and
Evidence.” Journal of Political Economy 86 (December):
971–987.
Hall, Robert E. 1988. “Intertemporal Substitution in
Consumption.” Journal of Political Economy 96 (April):
339–357.
Hayashi, Fumio. 1982. “Tobin’s Marginal q and
Average q: A Neoclassical Interpretation.” Econometrica 50
(January): 213–224.
Summers, Lawrence H. 1981. “Capital Taxation and
Accumulation in a Life Cycle Growth Model.” American
Economic Review 71 (September): 533–544.
29
OLENA V. BAZHENOVA
Summers, Lawrence H. 1981. “Taxation and

Corporate Investment: A q-Theory Approach.” Brookings
Papers on Economic Activity, no. 1, 67–127.
30
CHAPTER 3
LABOUR MARKETS
Keywords
labour demand natural rate of unemployment
labour supply wage rigidity
real wage marginal productivity of labour (MPL)
full employment long-term unemployment
unemployment hysteresis
classical unemployment efficiency wage
structural unemployment the Shapiro-Stiglitz model
frictional unemployment minimum wage
3.1. Background
Unemployment, according to OECD, is when a

person above a specified age (usually 15) not being in paid
employment or self-employment but currently available for
work during the reference period.
31
OLENA V. BAZHENOVA
Classical (real-wage) unemployment means that

real wages are above the market-clearing level, and
consequently the number of job-seekers are higher than the
number of vacancies.
Cyclical (deficient-demand) unemployment
means that there is not sufficient aggregate demand to
supply jobs for those who want to be employed.
“Natural” rate of unemployment is unemployment
in case of the state of full employment in an economy.
The NAIRU, the Non-Accelerating Inflation Rate
of Unemployment, is the rate of unemployment that
means the labour market is in equilibrium, and there is no
pressure for rising inflation rates or their falling. According
to demand theory, inflation will accelerate in the absence of
wage and price controls in the case of low unemployment
rate.
Frictional (search) unemployment occurs when
worker is searching for a new job or is between jobs. This
unemployment can be voluntary that depends on individual
circumstances.
Structural unemployment means that there is a
discrepancy between the unemployed workers skills and the
ones needed to get jobs, and consequently a labour market
is unable to provide jobs for those who want to be
employed. Structural unemployment lasts longer than
frictional.
Long-term unemployment by European Union
statistics is unemployment lasting longer than one year.
Very long-term unemployment occurs when lasts over two
years.
32
Hysteresis is the inability of macroeconomic

variables to return to their equilibrium level after eliminating
the causes of change.
Flexibility of real wages occurs when
unemployment is unable to cause a decrease in real wages.
The Beveridge curve is a downward curve that
characterizes the relationship between the unemployment
rate and the vacancy rate. The position of this curve
measures the efficiency of the job filling process.
Downward wage rigidity is the situation when wages
can not be adjusted downwards leading to important
consequences for macroeconomic performance, especially
labour markets.
3.2. Tests
3.2.1. Natural unemployment or natural rate of
unemployment
a) contains cyclical unemployment;
b) contains frictional and structural unemployment;
c) equals zero;
d) all of the above;
e) none of the above.
3.2.2. If actual GDP equals potential, then

a) there is no cyclical unemployment;
b) the unemployment rate is equal to the natural one;
c) there is a frictional unemployment in the economy;
33
OLENA V. BAZHENOVA
3.2.3. If unemployment is characterized by hysteresis, then

a) recession may lead to an increase of the natural rate of
unemployment;
b) while conducting anti-inflationary policy, the ratio of
losses will be less;
c) recession won’t be able to affect the position of the
long-run Phillips curve;
3.2.4. What unemployment is “good” for economy?

a) cyclical unemployment;
b) frictional unemployment;
c) classical unemployment;
3.2.5. Unemployment that exceeds the natural rate of

unemployment is referred to as
d) structural unemployment;
e) all of the above;
f) none of the above.
3.2.6. Which of the following causes a reduction of the

natural rate of unemployment?
a) tight fiscal policy;
b) tight monetary policy combined with stimulating fiscal
policy;
34
c) rise of the minimum wage;

d) enhancement of the employment services activities
and retraining;
3.2.7. Increase of the unemployment benefits period will

lead to growth of
3.2.8. According to the Shapiro-Stiglitz model, the

equilibrium effective wage will rise if
a) the probability of losing a job reduces;
b) the probability of getting a job for the unemployed
decreases;
c) the probability of detecting of “shrinking” increases;
3.2.9. According to the Shapiro-Stiglitz model, the

equilibrium effective wage will
a) grow while exerting efforts;
b) equal wage for workers who do not shrink while
exerting efforts;
c) be lower than wage for shrinking workers while
exerting efforts;
d) be higher than wage of union members;
35
OLENA V. BAZHENOVA

3.2.10. According to the Shapiro-Stiglitz model, a positive

impact of technological progress leads to
a) growth of employment and effective wages;
b) decline of employment and effective wages;
c) decline of employment and growth of effective wages;
d) growth of employment;
e) growth of effective wages;
f) all of the above;
g) none of the above.
3.3. Problems
3.3.1. Tables below concern data on annual real minimum
wages (in 2019 constant prices at 2019 USD PPPs) and
annual unemployment rate among population ages 15-19.
Based on data presented in Tables 3.1 and 3.2, analyse the
impact of real minimum wages on unemployment rate
among population ages 15-19.
Justify the relationship between these indicators
theoretically and sketch the appropriate graphs.
36
Table 3.1. Annual real minimum wages (in 2019 constant

prices at 2019 USD PPPs)
2015 2016 2017 2018 2019
Belgium 23 235.1 23 013.8 22 986.1 22 746.8 22 872.6
Czech Republic 8 573.4 9 163.1 9 937.7 10 789.9 11 609.0
Estonia 8 264.4 9 098.5 9 616.2 9 890.2 10 443.5
France 21 920.1 22 016.6 21 994.5 21 860.3 21 949.0
Germany 23 382.8 23 268.3 23 845.6 23 439.6 24 015.6
Greece 13 159.2 13 268.7 13 121.6 13 040.0 14 307.4
Hungary 8 884.6 9 355.4 10 511.8 11 049.2 11 544.5
Korea 15 125.4 16 187.9 17 037.8 19 540.8 21 586.1
Latvia 7 951.5 8 148.6 8 226.5 9 168.8 9 011.7
Lithuania 8 140.3 9 422.6 9 457.7 9 694.0 13 143.5
Luxembourg 25 459.6 25 385.8 25 935.3 25 811.0 26 252.5
Netherlands 24 347.9 24 741.1 24 843.1 24 859.9 24 826.5
Poland 11 790.2 12 547.3 13 288.8 13 704.8 14 363.8
Portugal 11 407.4 11 899.7 12 337.1 12 720.3 13 114.5
Spain 13 432.6 13 594.4 14 404.6 14 731.8 17 891.7
United Kingdom 18 937.6 20 610.8 20 721.4 21 132.2 21 764.4
United States 16 266.0 16 063.3 15 728.3 15 353.3 15 080.0
Source: OECD
Table 3.2. Annual unemployment rate for population ages

15-19
2015 2016 2017 2018 2019
Belgium 3.2 3.2 3.2 4.3 4.6
Czech Republic 3.6 3.2 4.2 4.1 4.3
Estonia 4.1 4.2 5.3 6.9 6.4
France 5.6 5.9 5.6 5.6 5.5
Germany 4.5 5.3 6.1 6.0 6.1
Greece 1.4 1.5 1.7 1.5 1.3
Hungary 3.5 3.8 4.3 4.7 5.7
Korea 3.0 2.7 2.3 1.9 1.8
Latvia 2.2 1.5 2.1 1.5 3.2
Lithuania 1.4 1.7 1.9 1.6 2.4
Luxembourg 7.4 7.5 5.5 7.2 7.6
Netherlands 14.2 16.1 16.5 16.9 17.0
Poland 2.8 3.6 3.0 3.1 3.5
Portugal 4.1 3.7 4.4 5.3 4.8
Spain 3.4 3.2 3.6 3.8 3.8
United Kingdom 17.2 17.2 17.1 15.5 15.6
United States 11.6 11.9 11.9 12.0 12.5
Source: OECD
37
OLENA V. BAZHENOVA
3.3.2. Based on data presented in Table 3.3, explain the

impact of trade union activities on labour markets in Europe
during 2015-2018.
Table 3.3. Trade union density rate 2 (in percentages,

administrative data)
2015 2016 2017 2018
Austria 27.4 26.9 26.7 26.3
Belgium 54.2 52.8 51.9 50.3
Czech Republic 12.0 12.0 11.7 11.5
Denmark 67.1 65.5 66.1 66.5
Estonia 4.7 4.4 4.3 4.3
Finland 66.4 64.9 62.2 60.3
France 9.0 9.0 8.9 8.8
Germany 17.6 17.0 16.7 16.5
Hungary 9.4 8.5 8.1 7.9
Iceland 90.0 89.8 .. 91.8
Italy 35.7 34.4 34.3 34.4
Latvia 12.6 12.3 12.2 11.9
Lithuania 7.9 7.7 7.7 7.1
Luxembourg 33.3 32.3 32.1 31.8
Netherlands 17.7 17.3 16.8 ..
Norway 49.3 49.3 49.3 49.2
Spain 15.2 14.8 14.2 13.6
Sweden 67.8 66.9 65.6 ..
Switzerland 15.7 15.3 14.9 ..
United Kingdom 24.2 23.7 23.2 23.4
Source: OECD
Explain this impact theoretically and sketch the appropriate

graph.
Using additional information explain the prerequisites of
differences in trade union performance between European
countries.
2
By definition of International Labour Organization trade union density rate (%) is a
number of union members who are employees as a percentage of the total number of
employees
38
3.3.3. Data below concerns public expenditure on labour

market programmes by main categories as a percentage of
GDP in 2017.
Given this data, identify active and passive measures and
analyse the effectiveness of labour market programmes.
Discuss the results.
Table 3.4. Public expenditure on labour market

programmes by main categories as a percentage of GDP in
2017
Sheltered Out-of-
PES Emp- and Start- work
Direct
and loy- supported up income Early
Prog- Trai- job
admi- ment employ- ince- mainte- retire- Total
rammes ning crea-
nistra- incen- ment and nti- nance ment
tion
tion tives rehabilita- ves and
tion support
Austria 0.18 0.44 0.07 0.02 0.06 0.01 1.26 0.15 2.19
Belgium 0.34 0.14 0.22 0.14 0.04 0.00 1.04 0.36 2.27
Czech
Republic 0.11 0.01 0.03 0.11 0.04 0.00 0.16 0.00 0.47
Denmark 0.40 0.46 0.20 0.91 0.00 0.00 0.96 0.13 3.05
Estonia 0.14 0.07 0.03 0.17 0.00 0.01 0.38 0.00 0.80
Finland 0.14 0.44 0.08 0.12 0.18 0.02 1.58 0.00 2.57
France 0.24 0.28 0.04 0.09 0.20 0.02 1.97 0.00 2.85
Germany 0.39 0.18 0.03 0.02 0.01 0.01 0.75 0.00 1.40
Greece .. 0.01 0.05 0.00 0.12 0.00 0.47 0.03 ..
Hungary 0.07 0.03 0.12 0.00 0.62 0.02 0.22 0.00 1.07
Source: OECD
39
OLENA V. BAZHENOVA
Table 3.4. Public expenditure on labour market programmes by

main categories as a percentage of GDP in 2017, continued
Out-
Sheltered of-
PES Emp- and Start- work
Direct Early
and loy- supported up income
Trai- job reti-
Programmes admi- ment employ- ince- mainte- Total
ning crea- re-
nistra- incen- ment and nti- nance
tion ment
tion tives rehabilita- ves and
tion suppor
t
Ireland 0.06 0.14 0.04 0.01 0.14 0.00 0.84 0.00 1.24
Italy .. .. .. 0.01 .. .. 1.21 0.01 ..
Japan 0.07 0.01 0.06 0.01 0.00 0.00 0.15 0.00 0.30
Korea 0.04 0.03 0.04 0.02 0.16 0.03 0.32 0.00 0.64
Latvia 0.05 0.07 0.04 0.00 0.02 0.00 0.40 0.00 0.59
Netherlands 0.22 0.07 0.04 0.31 0.01 0.00 1.51 0.00 2.15
Norway 0.15 0.11 0.11 0.10 0.00 0.00 0.49 0.00 0.96
Poland 0.08 0.01 0.10 0.17 0.02 0.04 0.10 0.10 0.62
Portugal 0.05 0.16 0.15 0.01 0.03 0.00 0.67 0.36 1.44
Slovak Republic 0.04 0.01 0.11 0.04 0.01 0.01 0.20 0.13 0.55
Slovenia 0.08 0.03 0.06 0.00 0.07 0.00 0.43 0.00 0.68
Spain 0.15 0.11 0.08 0.10 0.10 0.13 1.49 0.02 2.19
Sweden 0.28 0.13 0.48 0.24 0.00 0.12 0.53 0.00 1.78
Switzerland 0.11 0.18 0.08 0.24 0.00 0.00 0.67 0.00 1.28
United States 0.02 0.03 0.01 0.03 0.00 0.00 0.14 0.00 0.24
Source: OECD
3.4.1. Interindustry Wage Differences

The basic idea of efficiency-wage models is that firms may
pay wages above market-clearing levels. If there are reasons
for firms to do this, those reasons are unlikely to be equally
important everywhere in the economy. Motivated by this
observation, investigate whether some industries pay
systematically higher wages than others.
40
A typical specification is
M N
ln wi      j X ij    k Dik   i ,
j 1 k 1
where wi is worker i’s wage, the Xi j’s are worker

characteristics (such as age, education, occupation, and so
on), and the Dik’s are dummy variables for employment in
different industries.
In a competitive, frictionless labour market, wages depend
only on workers’ characteristics and not on what industry
they are employed in. Thus, if the X’s adequately capture
workers’ characteristics, the coefficients on the industry
dummies will be zero.
Use observations on hourly wage rates, education, and other
variables from the 2008 from Current Population Survey
(CPS) to estimate the coefficients of the model and confirm
or reject influence of industry dummies on workers’ wage.
Required
University press.
McGraw-Hill.
41
OLENA V. BAZHENOVA
Recommended
Blanchard, Olivier J., and Gali, Jordi. 2007. “Real
Wage Rigidities and the New Keynesian Model.” Journal of
Money, Credit, and Banking 39 (February): 35–65.
Blanchard, Olivier J., and Summers, Lawrence, H.
1986. “Hysteresis and the European Unemployment
Problem.” NBER Macroeconomics Annual 1: 15–78.
Shapiro, Carl, and Stiglitz, Joseph E. 1984.
“Equilibrium Unemployment as a Worker Discipline
Device” American Economic Review 74 (June): 433–444.
Summers, Lawrence H. 1988. “Relative Wages,
Efficiency Wages, and Keynesian Unemployment.”
American Economic Review 78 (May): 383–388.
Taylor, John B. 1979. “Staggered Wage Setting in a
Macro Model.” American Economic Review 69 (May):
108–113.
42
CHAPTER 4
ECONOMIC GROWTH
Keywords
economic growth the Solow residual
the Ramsey-Cass-Koopmans
production function
model
constant-relative-risk-aversion
effective labour
(CRRA) utility
households’ maximization
effective capital
problem
Inada conditions Euler equation
the Solow growth model the Diamond model
balanced growth path endogenous growth
actual and break-even investment R&D sector
golden rule level of the capital stock learning-by-doing
convergence the Romer model
speed of convergence human capital
growth accounting model with human capital
43
OLENA V. BAZHENOVA
4.1. Background
Economic growth is an increase of output in an
economy, which is usually measured by GDP per capita
growth rate.
Production function is a theoretical relationship
between total output and production factors.
Return on scale is an impact of factors quantities
increasing by the same percent on amount produced. If the
output produced increases by the same percent, the
production function has a constant return on scale; if the
amount produced increases by a greater or lesser percent,
rather than proportionally, it means an increasing or
decreasing return on scale.
Marginal cost of capital is a weighted average cost
of additional unit of capital raised.
Marginal product of capital is an additional amount
of output produced because of the use of an additional unit
of capital in case of constant amount of labour.
Inada conditions mean that the marginal product of
capital increases when the capital stock becomes smaller,
and vice versa.
Break-even investment is the amount of investment
that have to be raised to keep capital stock at its existing
level.
Balanced growth means the steady growth of the
economy, in which some important relations remain
unchanged, such as the ratio of capital to the amount of
efficient labour.
44
The golden rule level of the capital stock is level of

capital when consumption is at its maximum possible level
among balanced growth paths.
Convergence hypothesis is a hypothesis about the
relationship between per capita growth and initial GDP per
capita. The hypothesis helps to explain why poor economies
grow at faster rate than rich ones.
The Solow residual is referred to as a measure of the
contribution of technological progress into the output per
worker growth.
Households’ maximization problem means that
the representative household is willing to maximize its
lifelong utility subject to its budget constraint.
Euler equation states that consumption per worker
is increasing if the real return is higher than the discount rate
at which the household values future consumption relative
to current one, and vice versa.
Endogenous growth is the growth resulted from
decisions made by private agents in response to economic
conditions rather than the exogenous evolution of
technological progress.
Learning-by-doing is the process when workers
learn from their experiences while engaging in making
things.
Human capital is the stock of knowledge, different
social and personal attributes of people enabling enhanced
quality and growth of amount produced.
45
OLENA V. BAZHENOVA
4.2. Tests
4.2.1. The Solow growth model focuses on

a) the behaviour of households;
b) the dynamics of capital accumulation;
c) the creation and dissemination of technology;
d) the dynamics of consumption;
4.2.2. In the economy there is a constant return on scale, if

a) the economy is large enough, absolutely limited
resources do not play a crucial role, and markets are
perfectly competitive;
b) the economy is large enough, relatively limited
resources do not play a crucial role, and markets are
perfectly competitive;
c) the economy is large enough, absolutely limited
resources do not play a crucial role, and markets have
a structure of monopolistic competition;
4.2.3. In the capital dynamics equation of the Solow growth

model
a) the first term, which is equal to the product of saving
rate and output per unit of effective labour, shows the
amount of investment per unit of effective labour
required to keep capital stock at the existing level;
b) the first term, which is equal to the product of the
saving rate and the output per unit of effective labour,
46
indicates the actual investment per unit of effective

labour;
c) the second term, which is equal to the product of
capital stock and the sum of growth rates of technical
progress, population and depreciation rates, shows the
amount of investment per unit of effective labour
required to keep capital stock remains at existing level;
d) the second term, which is equal to the product of
capital stock and the sum of the growth rates of
technical progress, population and depreciation rates,
shows the actual amount of investment per unit of
effective labour.
4.2.4. On the balanced growth path

a) the rate of capital growth equals the rate of technical
progress;
b) the rate of economic growth equals the sum of growth
rates of technological progress and population;
c) the rate of capital growth is zero;
d) the growth rate of consumption per capita equals the
rate of technological progress;
e) output per unit of effective labour increases with the
pace of technical progress.
4.2.5. Long-term growth in the Solow model is possible only

due to
a) growth of the parameter of labour efficiency;
b) increase of the saving rate;
c) reduction of population growth rate;
47
OLENA V. BAZHENOVA
4.2.6. The production function in the Solow growth model

with natural resources has constant return on scale
a) by all arguments;
b) on accumulated resources;
c) on effective labour and capital;
4.2.7. On the balanced growth path in Solow growth model

with natural resources, the growth rate of capital
a) positively depends on population growth rate;
b) negatively depends on the growth rate of technological
progress;
c) positively depends on the growth rate of natural
resources;

with natural resources, the slowdown in growth at the
expense of natural resources is higher,
a) the greater the initial stock of resources;
b) the higher the population growth rate;
c) the slower the growth rate of technical progress;
d) the greater the rate of disposal of non-renewable
factors.

with natural resources
a) the growth rates of capital and output are the same;
b) capital is growing faster than output;
48
c) output growth rate is higher than the sum of

technological progress and population growth rates;
d) output grows at a rate that equals the sum of the
growth rates of technological progress and population.
4.2.10. According to the Solow growth model, if the real

interest rate is
a) higher than the sum of technological progress and
population growth rates, then capital stock is less than
the golden rule level of capital stock;
b) less than the sum of technological progress and
population growth rates, then capital stock is less than
the golden rule level of capital stock;
c) equal to the sum of technological progress and
population growth rates, then capital stock is at its
golden rule level.
4.2.11. The Solow growth model explains the existence of

convergence by the fact that different countries initially have
a) different size of capital efficiency of effective labour;
b) different saving rates;
c) different population growth rates;
4.2.12. In the Ramsey-Cass-Koopmans model absolutely

limited resources cause
a) slowing growth;
b) accelerating growth;
c) all of the above;
49
OLENA V. BAZHENOVA
d) none of the above.
4.2.13. In the Ramsey-Cass-Koopmans model the only

limitation on the structure of markets is
a) perfect competition in the market of final products;
b) perfect competition in the markets of goods and
services and capital;
c) perfect competition in the markets of goods and
services, labour and capital;
4.2.14. An increase in the subjective discount factor in the

Diamond model will lead to (other things being equal)
a) increase in consumption in the first period and
decrease in the second one;
b) decrease in consumption in the first and the second
periods;
c) decrease in consumption in the first period and
increase in the second one;
d) increase in consumption in the first and the second
periods.
4.2.15. If the rate of return is higher than the subjective

discount factor (other things being equal),
a) consumption in the first period will be less than in the
second one;
b) consumption in the first period will be higher than in
the second one;
c) consumption won’t change;
50
4.2.16. The source of macroeconomic (dynamic)

inefficiency in the Diamond model is
a) suboptimal dynamics of capital accumulation;
b) incomplete information at the micro level;
c) insufficient capital accumulation;
4.2.17. The balanced growth path in the Diamond model is

dynamically inefficient if
a) the real interest rate exceeds the growth rate of the
economy;
b) the growth rate of the economy does not exceed the
real interest rate;
c) capital accumulation is insufficient;
4.3. Problems
4.3.1. Table 4.1 concerns data on gross capital formation

and gross savings as a percent of GDP in 32 countries in
2018.
Explain why these indicators are highly correlated.
Gross savings are much greater than gross capital formation
in some countries, for instance in Netherlands, Norway and
Singapore. Explain this phenomenon.
51
OLENA V. BAZHENOVA
Table 4.1. Gross capital formation and gross savings as a

percent of GDP in 32 countries in 2018
Gross capital formation Gross savings
Country
(% of GDP) (% of GDP)
Austria 25.11 27.64
Australia 24.49 21.74
Belgium 25.48 24.54
Canada 23.07 19.67
China 43.79 44.56
Czech Republic 26.27 26.41
Denmark 22.96 29.98
Estonia 26.22 29.16
Finland 25.10 23.53
France 23.87 22.73
Germany 21.80 29.31
Israel 21.80 24.39
Japan 24.32 27.84
Italy 18.32 20.81
Korea, Rep. 31.31 35.68
Latvia 23.04 22.68
Lithuania 19.80 20.34
Netherlands 20.66 31.85
Norway 27.34 35.89
Portugal 18.10 18.09
Poland 20.70 19.71
Singapore 25.49 43.92
Slovak Republic 23.17 22.19
Spain 20.38 22.31
Switzerland 22.70 34.68
Sweden 26.01 28.44
Turkey 29.58 27.05
Ukraine 18.59 15.21
United Kingdom 17.20 13.32
United States 20.97 18.55
Source: World Bank
4.3.2. Human capital

Explain the impact of human capital on economic growth
in advanced and emerging economies based on data
presented in Table 4.2.
52
Describe probable poverty traps in these countries. Discuss

the ways to overcome them.
Table 4.2. Human capital indicators in eight countries in

2017
Educational
attainment, at least
Human School Gross
completed upper
capital index enrollment, capital
Country secondary,
(HCI) (scale secondary (% formation
population 25+,
0-1) gross) (% of GDP)
total (%)
(cumulative) 3
Brazil 46.17 0.56 100.83 14.63
Germany 83.46 0.80 98.41 20.75
Hong Kong 63.27 0.82 105.35 22.07
Mexico 34.11 0.61 104.39 22.97
Pakistan 27.25 0.39 40.40 16.15
Singapore 71.40 0.88 107.57 27.35
United States 89.81 0.76 98.95 20.66
United
Kingdom 77.11 0.78 125.85 17.52
Source: World Bank
4.3.3. Describe the impact of migration processes in the EU

on marginal product of capital and real wages since 2010.
Comment on the results.
4.4.1. Examine convergence from 1960 to 2019 in 39

advanced economies (IMF classification) based on
regression of output growth on a constant and growth in
1960 proposed by Baumol (1986):
3
For Germany and the US data is for 2018
53
OLENA V. BAZHENOVA
 Y    Y    Y  
ln     ln        ln     i ,
 L 2019,i   L 1960,i   L 1960,i 
Y 
where ln   is a logarithm of per capita output, i -
L
disturbances. For this purpose, use World Development
Indicators dataset by World Bank.
Confirm if there is a convergence or otherwise by sketching
a graph.
Discuss the obtained results.
4.4.2. Justify or reject Feldstein-Horioka phenomenon

(Feldstein-Horioka, 1980) in emerging market and
developing economies (IMF classification) based on the
panel regression model using data from 1970 to 2019:
I S
          i ,t ,
 Y i , t  Y i , t
where  I  ,  S  are investment and savings rates

Y  Y 
respectively,  - error term, and i indicates countries, t
indexes years.
4.4.3. Accounting for cross-country income differences

Estimate following regression
Y   K H
ln    ln    ln    ln Ai ,t
 L i , t 1    Y i , t  L i , t
to decompose cross-country income differences into the

contributions of physical-capital accumulation K/Y, human-
capital accumulation H/L, and other factors A separately
for advanced economies and emerging market and
developing economies.
54
Compare and discuss results.
Required
Barro, Robert J., and Sala-i-Martin, Xavier. 2003.
Economic Growth, 2d ed. Cambridge, MA: MIT Press.
University press.
McGraw-Hill.
Recommended
Abramovitz, Moses. 1956. “Resource and Output
Trends in the United States since 1870.” American
Economic Review 46 (May): 5–23.
Aghion, Philippe, and Howitt, Peter. 1992. “A Model
of Growth through Creative Destruction.” Econometrica 60
(March): 323–351.
Barro, Robert J., Mankiw, N. Gregory, and Sala-i-
Martin, Xavier. 1995. “Capital Mobility in Neoclassical
Models of Growth.” American Economic Review 85
(March): 103–115.
“Convergence across States and Regions.” Brookings
Papers on Economic Activity, no. 1, 107–182.
55
OLENA V. BAZHENOVA

“Convergence.” Journal of Political Economy 100 (April):
223–251.
Baumol, William. 1986. “Productivity Growth,
Convergence, and Welfare.” American Economic Review
76 (December): 1072–1085.
Diamond, Peter A. 1965. “National Debt in a
Neoclassical Growth Model.” American Economic Review
55 (December ): 1126–1150.
Feldstein, Martin, and Horioka, Charles. 1980.
“Domestic Saving and International Capital Flows.”
Economic Journal 90 (June): 314–329.
Grossman, Gene M., and Helpman, Elhanan. 1991a.
Innovation and Growth in the Global Economy.
Cambridge, MA: MIT Press.
Grossman, Gene M., and Helpman, Elhanan. 1991b.
“Endogenous Product Cycles.” Economic Journal 101
(September): 1214–1229.
Jones, Charles I. 1994. “Economic Growth and the
Relative Price of Capital.” Journal of Monetary Economics
34 (December): 359–382.
Jones, Charles I. 1995a. “R&D-Based Models of
Economic Growth.” Journal of Political Economy 103
(August): 759–784.
Jones, Charles I. 1995b. “Time Series Tests of
Endogenous Growth Models.” Quarterly Journal of
Economics 110 (May): 495–525.
Jones, Charles I. 2002a. “Sources of U.S. Economic
Growth in a World of Ideas.” American Economic Review
92 (March): 220–239.
Jones, Charles I. 2002b. Introduction to Economic
Growth, 2d ed. New York: W. W. Norton.
56
Koopmans, Tjalling C. 1965. “On the Concept of

Optimal Economic Growth.” In The Economic Approach
to Development Planning. Amsterdam: Elsevier.
Krugman, Paul R. 1979. “A Model of Innovation,
Technology Transfer, and the World Distribution of
Income.” Journal of Political Economy 87 (April): 253–266.
Maddison, Angus. Growth and Interaction in the
World Economy. URL: http://www.ggdc.net/maddison/
other_books/growth_and_interaction_in_the_world_econ
omy.pdf
Ramsey, F. P. 1928. “A Mathematical Theory of
Saving.” Economic Journal 38 (December): 543–559.
Romer, Paul M. 1990. “Endogenous Technological
Change.” Journal of Political Economy 98 (October, Part 2):
S71–S102.
Solow, Robert M. 1956. “A Contribution to the
Theory of Economic Growth.” Quarterly Journal of
Economics 70 (February): 65–94.
Solow, Robert M. 1957. “Technical Change and the
Aggregate Production Function.” Review of Economics and
Statistics 39: 312–320.
Solow, Robert M. 1960. “Investment and Technical
Progress.” In Kenneth J. Arrow, Samuel Korbin, and Patrick
Suppes, eds., Mathematical Methods in the Social Sciences
1959, 89–104. Stanford: Stanford University Press.
Swan, T. W. 1956. “Economic Growth and Capital
Accumulation.” Economic Record 32 (November): 334–
361.
Young, Alwyn. 1995. “The Tyranny of Numbers:
Confronting the Statistical Reality of the East Asian Growth
Experience.” Quarterly Journal of Economics 110 (August):
641–680.
57
OLENA V. BAZHENOVA
CHAPTER 5
INFLATION AND BUSINESS
CYCLES
Keywords
inflation aggregate supply
cost inflation aggregate demand
core inflation Okun’s law
headline inflation the Phillips curve
demand-pull inflation stagflation
supply-pull inflation IS-LM-BP model
supply shock RBC model
demand shock
5.1. Background
Inflation means a steady rise in prices in the economy.

Cost inflation is inflation caused by negative
aggregate supply shocks.
58
Core inflation means the long run tendency in the

inflation.
Headline inflation represents the total inflation in an
economy.
Demand-pull inflation is inflation caused by an
increase in aggregate demand.
Aggregate demand is the sum of household
consumption expenditures, investments, public
procurement of goods and services, and net exports.
Supply shocks are exogenous increases in non-labour
costs.
The IS curve is the set of all combinations of interest
rate and output at which the market of goods and services is
in equilibrium.
The LM curve is the set of all combinations of
interest rate and income at which the money market is in
equilibrium.
The BP curve is a set of balance of payments
equilibrium points for given values of income abroad, the
real exchange rate and the world interest rate.
Equilibrium in the IS-LM model is an equilibrium
in both goods and services and money markets achieved at
the intersection of the IS and LM curves.
Equilibrium in the IS-LM-BP model is an
equilibrium in goods and services, money, and foreign
exchange markets achieved at the intersection of the IS, LM,
and BP curves.
The crowding-out effect is the effect that an increase
in one component of aggregate demand (public expenditure)
59
OLENA V. BAZHENOVA
leads to decrease in another component of aggregate

demand, namely a fall in investment.
The Phillips curve is the curve that links inflation and
unemployment.
Leading indicators are indicators warning about
approach of the next phase of business cycle.
Business cycles is a sequence of periods of rapid
economic growth, slowdown or recession, in which output
produced fluctuates around its long-term trend.
Okun's law means that a 1% reduction in the
unemployment rate leads to a 2-3% increase in output
produced.
External lag or influence lag is a group of lags
related to impact of economic policy on an economy.
Money neutrality is a statement that the money
supply does not affect real variables, such as real output or
unemployment, but affects the price level.
Demand for money (L) is a demand for real balances
because of necessity to keep wealth in the form money to
buy goods and services.
The velocity of money is the ratio of total
expenditures to real cash balances.
Money multiplier is the ratio of money supply to
money base.
A liquidity trap is a situation where population is
willing to keep all their wealth in the form of money at a
certain (rather low) interest rate.
60
5.2. Tests
5.2.1. The cause of demand-pull inflation is an increase in
a) income taxes;
b) prices on electricity;
c) money supply;
d) inventories of firms;
e) none of the above;
f) all of above.
5.2.2. During demand-pull inflation nominal GDP

a) grows at the same rate as real GDP;
b) grows faster than real GDP;
c) grows more slowly than real GDP;
d) declines at the same rate as real GDP;
e) none of the above;
f) all of above.
5.2.3. Nominal and real interest rates will be the same in a

given year if
a) the nominal interest rate is zero;
b) the real interest rate is zero;
c) inflation is zero;
d) the nominal exchange rate is equal to the real one;
5.2.4. The Phillips curve combines
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OLENA V. BAZHENOVA
a) inflation rate and the deviation of output from full

employment level;
b) the level of cyclical unemployment and the deviation
of output from the full employment level;
c) growth rates of prices and output;
d) inflation rate and cyclical unemployment;
5.2.5. Long-run Phillips curve

a) has a negative slope;
b) has a positive slope;
c) is horizontal;
d) is vertical;
e) is more inclined than the short-run Phillips curve.
5.2.6. Which of the following will increase the loss ratio?

a) transition from short-term contracts to long-term
ones;
b) faster review of inflation expectations;
c) loss of confidence in the government;
5.2.7. The main conclusion of the Keynesian interpretation

of the Phillips curve is the existence of
a) a permanent trade-off between inflation and
unemployment while making macroeconomic
policies;
62
b) only a temporary trade-off between inflation and

policies;
c) permanent trade-off between high output and high
policies;
5.2.8. The Phillips curve is referred to as

a) aggregate supply curve;
b) aggregate demand curve;
c) money demand curve;
5.2.9. According to the modified Phillips curve, if actual

inflation exceeds its core level, then
a) the actual output will be above the potential level;
b) the actual output will be below the potential level;
c) the actual output equals its potential level;
5.2.10. An increase in core inflation will shift the modified

Phillips curve
a) left (up);
b) right (down);
c) no answer is correct.
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OLENA V. BAZHENOVA
5.2.11. As core inflation is a rate of actual inflation in

previous period, the modified Phillips curve assumes the
existence of
a) permanent trade-off between output and rising
inflation;
b) permanent trade-off between unemployment and
rising inflation;
c) permanent trade-off between output and inflation;
d) permanent trade-off between unemployment and
inflation.
5.2.12. According to the Phillips curve augmented by

inflation expectations, if actual inflation exceeds the
expected level, the actual output
a) will be above its potential level;
b) will be below its potential level;
c) equals its potential level;
5.2.13. Rising inflation expectations (as a parameter) will

shift the Phillips curve augmented by inflation expectations
a) left (up);
b) right (down);
c) there will be no shifts;
5.2.14. Consumption of goods

a) of short-term use is less volatile than output;
64
b) of long-term use is more volatile than output;

c) is acyclical;
d) is procyclical;
e) no answer is correct.
5.2.15. During recessions, there is a reduction in

a) number of jobs and hours per worker;
b) employment rate, but not in hours per worker;
c) consumption per worker;
5.2.16. The relative stability of the number of working hours

per employee leads to
a) real wage growth;
b) decline of real wages;
c) decrease of unemployment;
5.2.17. Most macroeconomic time series are

a) procyclical, as they are positively correlated with GDP
growth;
b) acyclical, as they are negatively correlated with GDP
growth;
c) countercyclical, as they have no correlation with GDP
growth;
d) acyclical, as they have no correlation with GDP
growth;
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OLENA V. BAZHENOVA
5.2.18. The dynamics of government spending and capital

stock is
a) acyclical;
b) procyclical;
c) countercyclical;
5.2.19. In a RBC model the main source of labour supply

fluctuations is
a) salary;
b) interest rate;
c) leisure time;
d) no answer is correct.
5.2.20. The disadvantage of basic model RBС is

a) a lack of internal mechanisms of shocks propagation;
b) a presence of internal mechanisms of shocks
propagation;
c) a presence of external mechanisms of shocks
propagation;
d) a lack of external mechanisms of shocks propagation;
e) no answer is correct.
5.2.21. The effect of the intertemporal substitution in labour

supply of Lucas and Rapping states that growth of
66
a) today's wages relative to future ones causes

households to increase labour supply in the future;
b) wages in the future causes current labour supply to
increase;
c) wages in the future causes the current supply of labour
to decrease;
d) interest rate increases the current labour supply
compared to the future;
e) interest rate decreases the current supply of labour
compared to the future.
5.3. Problems
5.3.1. Comment on the following statement: "Inflation does
not stimulate economic growth, regardless of its rate and
whether it is expected or unexpected".
5.3.2. Comment on the following statement: "An increase in

inflation expectations leads to a drop in output".
5.3.3. Comment on the following statement: "Rising the

growth rate of money supply by 1% causes an increase in
inflation by 1%".
5.3.4. Table 5.1 concerns data on annual unemployment rate

(% of total labour force) and consumer price index (2010 =
100) in four countries: Austria, Italy, Netherlands and
Norway.
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OLENA V. BAZHENOVA
Comment on the peculiarities of the Phillips curve in

mentioned economies.
Consider the influence of oil price shock on the Philips
curve in these countries.
Table 5.1. Annual unemployment rate (% of total labour

force) and consumer price index (2010 = 100)
Consumer price index Unemployment rate
Years Netherland
Austria Italy Netherlands Norway Austria Italy Norway
s
2012 105.9 105.9 104.9 102 4.9 10.7 5.8 3.1
2013 108 107.2 107.5 104.2 5.3 12.1 7.2 3.4
2014 109.7 107.5 108.5 106.3 5.6 12.7 7.4 3.5
2015 110.7 107.5 109.2 108.6 5.7 11.9 6.9 4.3
2016 111.7 107.4 109.5 112.4 6 11.7 6 4.7
2017 114 108.7 111 114.6 5.5 11.2 4.8 4.2
2018 116.3 110 112.9 117.7 4.8 10.6 3.8 3.8
2019 118.1 110.6 115.9 120.3 4.5 10 3.4 3.7
Source: World Bank
5.3.5. Describe the influence of commodities prices shocks

on core inflation in countries with central banks that target
inflation. Sketch the graphs.
5.3.6. Describe the consequences of rise of inflation for

output, exchange rate, external competitiveness, interest
rate, unemployment and money supply in such countries as
Japan, the UK, Turkmenistan and Panama. What is the key
difference between these countries?
Sketch the graphs.
What measures of monetary and fiscal policy would be
appropriate to stabilize the situation?
68
5.3.7. Describe supply shocks effect on output, exchange

rate, external competitiveness, interest rate, unemployment,
money supply in Ukraine. Give the examples of such shocks
in Ukraine. Sketch the graphs.
What measures of monetary and fiscal policy would be
appropriate to minimize the effect of supply shocks in the
future?
5.4.1. Consider the expectations augmented Phillips curve

for OECD countries that might be described by following
equation:
 t   0  1ut   2ut 1   3 te1   t .
Here πt is the inflation rate, πt = ln(Pt/Pt−1), where Pt is a
consumer price index of the economy; ut is the rate of
unemployment – or its log; πet+1 is the expected rate of
inflation one period ahead, and εt denotes error term.
Specify the hypotheses of expectations for future inflation:
1) Expectations are built on the last observed rate of
inflation, hence πet+1 =τπt−1, where the parameter τ is
typically positive, but not larger than 1.
2) A situation where central bank has an inflation target,
and firms and households base their expectations of
future inflation on the inflation target π*.
3) Robust forecasting rule, for instance
e
π t+1=(1−τ)π*+τπt−1, where the parameter τ is typically
positive, but not larger than 1.
Choose the appropriate functional form to estimate models
as in 2.4.1.
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OLENA V. BAZHENOVA
Find the estimates of the parameters.

Explain the signs of δ1 and δ2.
Comment on the results of the Phillips curve estimation in
OECD countries.
Required
University press.
McGraw-Hill.
Recommended
Ball, Laurence. 1993. “The Dynamics of High
Inflation.” National Bureau of Economic Research Working
Paper No. 4578 (December).
Ball, Laurence. 1994. “Credible Disinflation with
Staggered Price-Setting.” American Economic Review 84
(March): 282–289.
Ball, Laurence. 1994. “What Determines the Sacrifice
Ratio?” In N. Gregory Mankiw, ed., Monetary Policy, 155–
182. Chicago: University of Chicago Press.
70
Ball, Laurence. 1999. “Aggregate Demand and Long-

Term Unemployment.” Brookings Papers on Economic
Activity, no. 2, 189–251.
Ball, Laurence. 1999. “Efficient Rules for Monetary
Policy.” International Finance 2 (April): 63–83.
Ball, Laurence, and Cecchetti, Stephen G. 1990.
“Inflation and Uncertainty at Short and Long Horizons.”
Brookings Papers on Economic Activity, no. 1, 215–254.
Ball, Laurence, Elmendorf, Douglas W., and Mankiw,
N. Gregory. 1998. “The Deficit Gamble.” Journal of Money,
Credit, and Banking 30 (November): 699–720.
Ball, Laurence, and Mankiw, N. Gregory. 1995.
“Relative-Price Changes as Aggregate Supply Shocks.”
Quarterly Journal of Economics 110 (February): 161–193.
Ball, Laurence, Mankiw, N. Gregory, and Romer,
David. 1988. “The New Keynesian Economics and the
Output-Inflation Tradeoff.” Brookings Papers on
Economic Activity, no. 1, 1–65.
Ball, Laurence, and Moffitt, Robert. 2001.
“Productivity Growth and the Phillips Curve.” In Alan B.
Krueger and Robert M. Solow, eds., The Roaring Nineties:
Can Full Employment Be Sustained? 61–91. New York:
Russell Sage Foundation.
Basu, Susanto. 1995. “Intermediate Goods and
Business Cycles: Implications for Productivity and Welfare.”
American Economic Review 85 (June): 512–531.
Basu, Susanto. 1996. “Procyclical Productivity:
Increasing Returns or Cyclical Utilization?” Quarterly
Journal of Economics 111 (August): 719–751.
Bernanke, Ben S., and Parkinson, Martin L. 1991.
“Procyclical Labor Productivity and Competing Theories of
the Business Cycle: Some Evidence from Interwar U.S.
Manufacturing Industries.” Journal of Political Economy 99
(June): 439–459.
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Bernanke, Ben S., and Woodford, Michael. 1997.

“Inflation Forecasts and Monetary Policy.” Journal of
Money, Credit, and Banking 29 (November, Part 2): 653–
684.
Bruno, Michael, and Easterly, William. 1998.
“Inflation Crises and Long-Run Growth.” Journal of
Monetary Economics 41 (February): 3–26.
Caballero, Ricardo J., and Lyons, Richard K. 1992.
“External Effects in U.S. Procyclical Productivity.” Journal
of Monetary Economics 29 (April): 209–225.
Cagan, Philip. 1956. “The Monetary Dynamics of
Hyperinflation.” In Milton Friedman, ed., Studies in the
Quantity Theory of Money, 25–117. Chicago: University of
Chicago Press.
Carlton, Dennis W. 1982. “The Disruptive Effects of
Inflation on the Organization of Markets.” In Robert E.
Hall, ed., Inflation: Causes and Effects, 139–152. Chicago:
University of Chicago Press.
Christiano, Lawrence J., and Eichenbaum, Martin.
1992. “Current Real-Business-Cycle Theories and Aggregate
Labor-Market Fluctuations.” American Economic Review
82 (June): 430–450.
Christiano, Lawrence J., Eichenbaum, Martin, and
Evans, Charles. 1996. “The Effects of Monetary Policy
Shocks: Evidence from the Flow of Funds.” Review of
Economics and Statistics 78 (February): 16–34.
Gali, Jordi. 2008. Monetary Policy, Inflation, and the
Business Cycle: An Introduction to the New Keynesian
Framework. Princeton, NJ: Princeton University Press.
Gal´ı, Jordi, and Gertler, Mark. 1999. “Inflation
Dynamics: A Structural Econometric Analysis.” Journal of
Monetary Economics 44 (October): 195–222.
Gali, Jordi, and Rabanal, Pau. 2004. “Technology
Shocks and Aggregate Fluctuations: How Well Does the
72
Real Business Cycle Model Fit Postwar U.S. Data?” NBER

Macroeconomics Annual 19: 225–288.
Kydland, Finn E., and Prescott, Edward C. 1982.
“Time to Build and Aggregate Fluctuations.” Econometrica
50 (November): 1345–1370.
Mankiw, N. Gregory. 1989. “Real Business Cycles: A
New Keynesian Perspective.” Journal of Economic
Perspectives 3 (Summer): 79–90.
Nordhaus, William D. 1975. “The Political Business
Cycle.” Review of Economic Studies 42 (April): 169–190.
Okun, Arthur M. 1971. “The Mirage of Steady
Inflation.” Brookings Papers on Economic Activity, no. 2,
485–498.
Okun, Arthur M. 1975. “Inflation: Its Mechanics and
Welfare Costs.” Brookings Papers on Economic Activity,
no. 2, 351–390.
Phelps, Edmund S. 1968. “Money-Wage Dynamics
and Labor Market Equilibrium.” Journal of Political
Economy 76 (July/August, Part 2): 678–711.
Phelps, Edmund S. 1970. “Introduction.” In Edmund
S. Phelps et al., Microeconomic Foundations of
Employment and Inflation Theory. New York: W. W.
Norton.
Phelps, Edmund S. 1973. “Inflation in the Theory of
Public Finance.” Swedish Journal of Economics 75 (March):
67–82.
Phelps, Edmund S., and Taylor, John B. 1977.
“Stabilizing Powers of Monetary Policy under Rational
Expectations.” Journal of Political Economy 85 (February):
163–190.
Phillips, A. W. 1958. “The Relationship between
Unemployment and the Rate of Change of Money Wages in
the United Kingdom, 1861–1957.” Economica 25
(November): 283–299.
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CHAPTER 6
MACROECONOMIC POLICY
Keywords
seignorage the Lucas’s critique
inflation tax active stabilization policy
fiscal policy passive stabilization policy
monetary policy shock therapy
central bank independence public debt
central bank independence indexes the Kagan’s model
the Laffer curve
6.1. Background
Fiscal policy is a policy that uses tax rates and public
spending as tools by which a government influences an
economy. It is also referred to as budget and tax policy.
Monetary policy is a policy implemented by the
central bank to influence money supply and, therefore,
74
achieve macroeconomic objectives that ensure sustained

economic growth.
Monetary expansion is a policy aimed at increasing
the money supply and, consequently, output produced.
Monetary contraction is a policy aimed at reducing
the money supply and, consequently, output produced.
Mixed policy is a combination of monetary and fiscal
policies.
Central bank independence means an
independence of central bank’s policymakers from
governmental or political influence while conducting
monetary policy.
The Laffer curve demonstrates theoretical
relationship between tax rates and tax revenue levels.
Seigniorage is the government's use of the central
bank's monopoly power to create money as a means of
increase in real money balances.
Inflation tax is a loss of cash and cash equivalents by
their holders due to of inflation.
Active stabilization policy is a policy aimed at
neutralizing exogenous shock.
Passive stabilization policy is a policy of non-
interference when nothing is done to stimulate the return of
the economy to output at full employment.
Shock therapy is a sharp decrease in the growth rate
of money supply to a level that provides a significant
reduction in inflation.
Public debt is a total outstanding debt of central
government of the country.
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OLENA V. BAZHENOVA
The decision lag is related to the time required to

predict the consequences of the shock and develop an
appropriate decision.
The Lucas' critique is the hypothesis that
households and firms take public policy measures into
account in their behaviour; as a result, changes in public
policy can significantly affect the behaviour of these agents.
The Lucas' critique is the inadequacy of econometric
economic policy forecasts that do not take into account
changes in agents' expectations.
The Kagan function is a function of demand for
money expressed a function of expected inflation.
6.2. Tests
6.2.1. The primary budget deficit is defined as

a) difference between public expenditure (not including
interest on debt service) and public revenue;
b) difference between public expenditure (including
interest payments) and public revenues;
c) sum of public expenditure (including interest
payments) and public revenue;
6.2.2. The operating budget deficit is defined as

a) difference between public expenditure (excluding
interest payments) and public revenue;
b) difference between public expenditure (including debt
service interest payments) and public revenue;
76
c) sum of public expenditure (including interest

payments) and public revenue;
6.2.3. Seigniorage is
a) nominal income of the government from money
issuance;
b) real income of the government from money issuance;
c) tax on nominal income of the government from
money issuance;
d) tax on real income of the government from money
issuance
6.2.4. The condition of no Ponzi games requires the

following:
a) the net present value of public debt should tend to
zero over an indefinite time horizon;
b) the value of government debt must equal zero on an
infinite horizon;
c) the government must sooner or later repay its debt in
full;
d) public debt should not grow over time.
6.2.5. The dynamic budget constraint of the government

determines
a) dynamics of public debt over time for a certain (initial)
value of debt and given trajectories of public
expenditures and revenues (including seigniorage);
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OLENA V. BAZHENOVA
b) dynamics of public expenditures in time for a certain

(initial) value of debt and given trajectories of public
debt and budget revenues (including seigniorage);
c) all of the above;
6.2.6. The burden on the public budget

a) additionally increases when the interest rate on
government bonds becomes negative;
b) significantly reduces when the interest rate on
government bonds becomes negative;
c) does not change when the interest rate on government
bonds fluctuates;
6.2.7. The main goals of debt policy are

a) minimization of expected debt service costs and debt
service risk;
b) minimizing the amount of debt and risk of debt
service;
c) minimization of expected debt service costs and debt
repayment period;
d) minimization of the amount of debt and term of debt
repayment.
6.2.8. Seigniorage, as the real income of the central bank

from issuance of money supply, can be represented as
a) increase in money supply divided by the price level;
b) increase in monetary base divided by the price level;
78
c) product of monetary base and monetary base growth

rate;
d) product of real money balances and monetary base
growth rate;
e) product of logarithm of monetary base and monetary
base growth rate.
6.2.9. Seigniorage can be decomposed into

a) net seigniorage and inflation tax;
b) net seigniorage and inflation rate;
c) net seigniorage (increase in real money balances) and
inflation tax (increase in monetary base);
6.2.10. Inflation tax is defined as

a) pure seigniorage;
b) product of inflation rate and real money balances;
c) product of inflation rate and monetary base;
d) the product of inflation rate and the logarithm of
monetary base;
6.2.11. Pure seigniorage is defined as

a) net increase in the monetary base;
b) increase in real money balances;
c) seigniorage except for inflation tax;
d) decrease in real money balances.
6.2.12. In a steady state of money market pure seigniorage
79
OLENA V. BAZHENOVA
a) is zero;
b) coincides with the inflation tax;
c) coincides with the inflation rate;
6.2.13. In a steady state of money market (taking into

account GDP growth), the inflation rate is equal to
a) the monetary base growth rate except for GDP
growth rate;
b) the monetary base growth rate plus GDP growth rate;
c) zero;
6.2.14. The demand function for real money balances of

Kagan determines the negative dependence of real money
balances on
a) inflation expectations;
b) inflation;
c) inflation tax;
6.2.15. Semi-elasticity of demand for real money balances on

inflation expectations is defined as
a) relative increase in real money balances divided by
absolute increase in inflation expectations;
b) relative increase in real money balances divided by
relative increase in inflation expectations;
c) absolute increase in real money balances divided by
relative increase in inflation expectations;
80
6.2.16. In the Kagan's model with adaptive expectations

inflation dynamics is
a) stable and its level asymptotically converges to the
monetary base growth rate when the reaction of
economic agents is insensitive, αθ <1 (low rate of
adaptation of expectations and low sensitivity of
demand to inflation expectations);
b) volatile and its level exponentially converges to the
economic agents is insensitive, αθ <1 (low rate of
adaptation of expectations and low sensitivity of
demand to inflation expectations);
c) stable and its level asymptotically converges to the
economic agents is sensory, αθ> 1 (high rate of
adaptation of expectations and high sensitivity of
demand to inflationary expectations).
6.2.17. The Laffer curve means the dependence of the

inflation tax on
a) inflation rate;
b) the level of budget deficit;
c) level of taxation;
6.2.18. If expectations are adaptive, then provided α <1 (low

rate of adaptation of expectations and low sensitivity of
demand to inflation expectations) there will be stability of
a) low inflation, which corresponds to the growing part
of the Laffer curve;
b) high inflation, which corresponds to the declining
section of the Laffer curve;
81
OLENA V. BAZHENOVA
c) high inflation, which corresponds to the growing part

6.2.19. If expectations are adaptive, then provided αθ> 1

(high rate of adaptation of expectations and high sensitivity
of demand to inflation expectations) there will be stability of
a) low inflation, which corresponds to the growing part
b) high inflation, which corresponds to the declining
c) high inflation, which corresponds to the growing part
d) low inflation, which corresponds to the declining
6.2.20. The maximum of the Laffer curve is reached

a) at a point with a unit elasticity of demand for real
money balances on inflation expectations;
b) at a point with a unit semi-elasticity of demand for real
money balances on inflation expectations;
c) at the level of inflation equal to the value of the inverse
semi-elasticity of demand for real money balances on
inflation expectations;
82
6.3. Problems
6.3.1. Are the following statements true?

1) With the increase of taxes while maintaining the size
of transfers, the size of the trade balance, public
procurement and investment at the same level, the
amount of savings will decrease.
2) A decrease in the trade balance can lead to an increase
in investment if budget deficit and amount of savings
in an economy do not change.
3) Simultaneous growth of consumption and savings can
be associated only with an increase in transfers.
6.3.2. Comment on the following statements:

1) The sale of government bonds leads to an increase in
the public deficit.
2) An increase in the budget surplus at full employment
leads to a fall in consumption and investment.
3) Expansionary monetary policy leads to a fall in bond
prices provided the liquidity trap.
4) If the economy is in a liquidity trap, it is impossible to
achieve GDP growth.
5) Reducing the income tax rate will lead to increase in
consumption and fall of demand for money.
6.3.3. Does a country whose expenditures exceed revenues

always have a negative current account balance?
6.3.4. How will the levels of investment and savings change,

if it is assumed that while maintaining the previous values of
83
OLENA V. BAZHENOVA
other indicators, budget deficit will decrease and current

account deficit will increase?
6.3.5. In the late 1970s and early 1980s, a number of Latin

American countries had huge foreign debts.
How did this affect their balance of payments?
Which of the indicators - GDP or GNP – was larger during
this period?
6.3.6. Comment on the data concerning dynamics of gross

external debt, gross external debt to exports of goods and
services ratio and gross external debt to GNI ratio in
Ukraine in 2007-2016 (Figure 6.1.).
160.00 250
218.4
140.00 178.4 216.9
185.3 200
163.5 114.71
120.00 176.7
153.6 142.6
117.18
100.00
150
124.1 113 124.30
136.91 126.54
80.00 105.06 133.51 146.35 130.3 124.2
95.9 100
60.00 80.75 99.35
91.5 92.8 81.2
85.9 77.3
40.00
55.7 50
20.00
5.4
0.00 0
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Gross external debt, bil.$ Gross external debt to export ratio, % (right scale)
Gross external debt to GNI ratio , % (right scale)
Figure 6.1. Dynamics of gross external debt, gross external

debt to exports of goods and services ratio and gross
external debt to GNI ratio in Ukraine in 2007-2016
Source: World Bank
84

6.4.1. Central bank independence (CBI) is usually referred
to as the ability of central bank to control monetary
instruments. The central bank has the right to set its own
policy goals, for instance inflation targeting. Thus, central
banks are able to maintain low and stable inflation using
policy interest rates as a single an instrument.
Confirm/reject inflation rate and central banks (that target
inflation rate) independence index (CWN index)
relationship in OECD countries using models as in Alesina
and Summers (1993).
Required
University press.
McGraw-Hill.
Recommended
Aiyagari, S. Rao, Christiano, Lawrence J., and
Eichenbaum, Martin. 1992. “The Output, Employment, and
Interest Rate Effects of Government Consumption.”
Journal of Monetary Economics 30 (October): 73–86.
85
OLENA V. BAZHENOVA
Akerlof, George A., Dickens, William T., and Perry,

George L. 1996. “The Macroeconomics of Low Inflation.”
Brookings Papers on Economic Activity, no. 1, 1–76.
Alesina, Alberto, and Perotti, Roberto. 1997. “Fiscal
Adjustments in OECD Countries: Composition and
Macroeconomic Effects.” IMF Staff Papers 44 (June): 210–
248.
Alesina, Alberto, and Summers, Lawrence H. 1993.
“Central Bank Independence and Macroeconomic
Performance.” Journal of Money, Credit, and Banking 25
(May): 151–162.
Andersen, Leonall C., and Jordan, Jerry L. 1968.
“Monetary and Fiscal Actions: A Test of Their Relative
Importance in Economic Stabilization.” Federal Reserve
Bank of St. Louis Review 50 (November): 11–24.
Barro, Robert J. 1974. “Are Government Bonds Net
Wealth?” Journal of Political Economy 82
(November/December): 1095–1117.
Barro, Robert J. 1976. “Rational Expectations and the
Role of Monetary Policy.” Journal of Monetary Economics
2 (January): 1–32.
Barro, Robert J., and Redlick, Charles J. 2009.
“Macroeconomic Effects from Government Purchases and
Taxes.” National Bureau of Economic Research Working
Paper No. 15369 (September).
Bernanke, Ben S., and Gertler, Mark. 2001. “How
Should Central Bankers Respond to Asset Prices?”
American Economic Review 91 (May): 253–257.
Bernanke, Ben S., and Mihov, Ilian. 1998. “Measuring
Monetary Policy.” Quarterly Journal of Economics 113
(August): 869–902.
Blanchard, Olivier J. 1985. “Debts, Deficits, and Finite
Horizons.” Journal of Political Economy 93 (April): 223–
247.
86
Blanchard, Olivier J., and Perotti, Roberto. 2002. “An

Empirical Characterization of the Dynamic Effects of
Changes in Government Spending and Taxes on Output.”
Quarterly Journal of Economics 117 (November): 1329–
1368.
Blanchard, Olivier J., and Weil, Philippe. 2001.
“Dynamic Efficiency, the Riskless Rate, and Debt Ponzi
Games under Uncertainty.” Advances in Macroeconomics
1, no. 2, Article 3.
Bohn, Henning. 1988. “Why Do We Have Nominal
Government Debt?” Journal of Monetary Economics 21
(January): 127–140.
Bohn, Henning. 1990. “Tax Smoothing with Financial
Instruments.” American Economic Review 80 (December):
1217–1230.
Bohn, Henning. 1992. “Endogenous Government
Spending and Ricardian Equivalence.” Economic Journal
102 (May): 588–597.
Bohn, Henning. 1995. “The Sustainability of Budget
Deficits in a Stochastic Economy.” Journal of Money,
Credit, and Banking 27 (February): 257–271.
Calvo, Guillermo. 1988. “Servicing the Public Debt:
The Role of Expectations.” American Economic Review 78
(September): 647–661.
Clarida, Richard, Gali, Jordi, and Gertler, Mark. 2000.
“Monetary Policy Rules and Macroeconomic Stability:
Evidence and Some Theory.” Quarterly Journal of
Economics 115 (February): 147–180.
Cole, Harold L., and Kehoe, Timothy J. 2000. “Self-
Fulfilling Debt Crises.” Review of Economic Studies 67
(January): 91–116.
Friedman, Milton. 1971. “Government Revenue from
Inflation.” Journal of Political Economy 79 (July/August):
846–856.
87
OLENA V. BAZHENOVA
Ghosh, Atish R. 1995. “Intertemporal Tax-Smoothing

and the Government Budget Surplus: Canada and the
United States.” Journal of Money, Credit, and Banking 27
(November, Part 1): 1033–1045.
Giavazzi, Francesco, and Pagano, Marco. 1990. “Can
Severe Fiscal Contractions Be Expansionary? Tales of Two
Small European Countries.” NBER Macroeconomics
Annual 5: 75–111.
Levin, Andrew, Wieland, Volker, and Williams, John
C. 2003. “The Performance of Forecast-Based Monetary
Policy Rules under Model Uncertainty.” American
Economic Review 93 (June): 622–645.
McGrattan, Ellen R. 1994. “The Macroeconomic
Effects of Distortionary Taxation.” Journal of Monetary
Economics 33 (June): 573–601.
Pettersson-Lidbom, Per. 2001. “An Empirical
Investigation of the Strategic Use of Debt.” Journal of
Political Economy 109 (June): 570–583.
Phelps, Edmund S., and Taylor, John B. 1977.
“Stabilizing Powers of Monetary Policy under Rational
Expectations.” Journal of Political Economy 85 (February):
163–190.
Romer, Christina D., and Romer, David H. 2009.
“The Macroeconomic Effects of Tax Changes: Estimates
Based on a New Measure of Fiscal Shocks.”University of
California, Berkeley (April). American Economic Review.
Romer, Christina D., and Romer, David H. 2009. “Do
Tax Cuts Starve the Beast? The Effect of Tax Changes on
Government Spending.” Brookings Papers on Economic
Activity, no. 1, 139–200.
Roubini, Nouriel, and Sachs, Jeffrey D. 1989.
“Political and Economic Determinants of Budget Deficits
in the Industrial Democracies.” European Economic
Review 33 (May): 903–933
88
Tabellini, Guido, and Alesina, Alberto. 1990. “Voting

on the Budget Deficit.” American Economic Review 80
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89
FOR NOTES
FOR NOTES
91
OLENA V. BAZHENOVA
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APPLIED

Approved at the meeting of the Academic Council of the Faculty of Economics,

The textbook covers theoretical backgrounds, tests, problems

CHAPTER 1. INTRODUCTION ............................................................... 5

CHAPTER 2. PRIVATE SECTOR DEMAND ..................................15

CHAPTER 3. LABOUR MARKETS ..................................................31

CHAPTER 4. ECONOMIC GROWTH .................................................. 43

CHAPTER 5. INFLATION AND BUSINESS CYCLES ..................... 58

CHAPTER 6. MACROECONOMIC POLICY ...................................... 74

Gross domestic product (GDP) is the market value

includes three main sections: current account, capital

The dichotomy is the principle by which physical and

1.2.2. Macroeconomics examines economic processes at the

1.2.3. Сalculation of GDP does not take into account

1.2.4. Equilibrium in the economy is achieved if

a) the sum of planned and unplanned investments is

1.2.5. Nominal GNP is the value of goods and services

1.2.6. The most appropriate metric for measuring an annual

1.2.7. GDP is a macroeconomic indicator that reflects the

1.2.8. GDP and GNI differ by

1.2.9. Indicate which indicator is equal to the sum of net

1.2.10. During inflation

1.2.11. If the GDP deflator rose while real GDP was

1.2.12. The GDP / GNI of which country will include profit

1.3.1. The exchange rate of the Mexican peso to the dollar

1.3.2. A Big Mac in the US costs $ 4.33, in Sweden - 65 SEK.

1.3.3. How will the following transactions affect Germany's

e) the US banker sends money to his bank account in

1.3.4. Analyse data from the balance of payments in Poland

Table 1.1. Current, capital and financial accounts balances

1.3.5. Table 1.2 concerns data on GNI (formerly GNP) as

(fewer subsidies) not included in the valuation of output and

Table 1.2. GDP and GNI in 2019 (in current bil. $)

What are the causes of differences between GDP and GNI

1.4. Suggested reading

Investment is referred to as a supplement to the

Household consumption expenditures are

Permanent income is the averaged life cycle income.

2.2.1. If the consumer behaves as a borrower in the model

2.2.2. According to the theory of permanent income an

2.2.3. According to the permanent income hypothesis

2.2.4. With the growth of income tax consumption of

2.2.5. According to the life cycle hypothesis, the

2.2.6. According to the life cycle hypothesis, a person who

2.2.7. Which of the following statements are true:

2.2.8. When the price level in the economy increases, the

2.2.9. If the depreciation rate increases, then the real wealth

2.2.10. The growth of a stock of capital will affect the

d) it is impossible to say for sure.

2.2.11. A rise of interest rate in the model of loan financing

2.2.12. A rise in nominal wages leads to (in case of perfect

2.2.13. A rise of the company's share price causes

2.2.14. Payment of capital taxes causes

d) growth of the demand for gross investment (impact

2.2.15. A decrease in interest rates causes

2.2.16. An increase in the company's profit causes

2.2.17. Assume that in the flexible accelerator model, the

2.3.1. The data below concerns several macroeconomic

Figure 2.1. Oil price indexes in 2013-2019

Table 2.1. Macroeconomic indicators of the Russian

Table 2.2. Macroeconomic indicators of Qatar’s economy

Table 2.3. Macroeconomic indicators of Saudi Arabia’s

Table 2.4. Macroeconomic indicators of Nigeria’s economy