May Examination Period 2022

ECN355 Macroeconomic Policy Duration: 3 hours

Answer TWO questions, one from section A and one from section B.

This examination paper MUST NOT be shared with anyone else. Doing so will be considered a very
serious assessment offence under the Queen Mary Academic Misconduct Policy.

This examination is an individual assessment and must be entirely your own work. All work will be run
through the plagiarism software, Turnitin. The software will also compare your script against all other
student submissions. Any evidence of plagiarism or collusion will be taken forward as academic miscon-
duct.

Calculators are permitted in this examination.

Please ensure that your working is clearly shown with all steps of your calculation included in your an-
swer document, including any formula used.

All non-mathematical questions should be typed and not handwritten unless the student has obtained
an official exemption.

When writing formulas, please note the following:

• It is acceptable to use the standard alphabet rather than greek letters. The following are recom-
mended: m for µ, s for σ, w for ω, r for ρ, d for ∆, b for β, etc.
• For mathematical operators: add +, subtract -, multiply *, and divide /
• Where appropriate, use an underscore to indicate a subscript, Eg r_f for rf .
√
• Use the ^ character for power, eg x^2 for x2 , x^0.5 for x.
• As an alternative to x^.5 you may type sqrt(x).
• Use brackets as necessary. To make your answer clearer use different brackets where appropriate,
eg [ ] ()

Examiner: Prof F. X. Mateos-Planas

© Queen Mary, University of London, 2022
Page 2 ECN355 (2022)

Section A (answer ONE question)

Question 1
Explain how you would empirically investigate the effects of shocks to inflation, interest rates,
and unemployment using vector autoregressions. Specify some plausible short-run identification
restrictions and show how to implement them. Based on the findings from existing empirical
studies, what type of results would you expect to obtain about the impact of monetary policy
shocks? Assess the merits as well as the limitations of this type of empirical results for policy
analysis.

[50 marks]

Question 2
Assume an economy far from the zero lower bound. Describe how an interest rate shock can be
modelled. Derive the impact effect on output and justify the determinants of this effect. Trace
the dynamics of the subsequent adjustment, explaining specifically how you would simulate it.
Does the model predict paths consistent with the impulse-response functions (IRF) obtained in
existing studies for the U.S.?

[50 marks]

Question 3

The UK, along with many other economies, is experiencing rising energy prices. What should the
Bank do in order to respond in an optimal way? Compare with the policy response if the Bank
were to adjust the interest rate to deviations of inflation from target according to an ad-hoc fixed
rule. If there is some ‘divine coincidence’, why do you think policymakers look so troubled today?

[50 marks]

Question 4

Explain the determinants of the multiplier of government spending when outside of a liquidity
trap. What is specifically the role of financial constraints, nominal rigidities, and the stance of the
central bank? Explain how the multipliers found in existing empirical studies are related to the
theoretical multipliers from the model.

[50 marks]
ECN355 (2022) Page 3

Section B (answer ONE question)

Question 5

Explain how an economy could fall into a liquidity trap. Specifically explain the role of monetary
policy in that explanation. Relate your explanation to some recent real-world situation. Do you
think that the liquidity trap remains relevant in 2022?

[50 marks]

Question 6

Describe the channels and mechanisms of the effects of quantitative easing in a liquidity trap. Do
you think the legacy of large central bank asset purchases poses a threat today? Can you relate
your answer to the approach to quantitative tightening recently announced or pursued by central
banks?

[50 marks]

End of Paper