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Monetary Theory And Policy Question Paper

Monetary Theory And Policy

Course:Master Of Economics

Institution: Kenyatta University question papers

Exam Year:2009

KENYATTA UNIVERSITY
UNIVERSITY EXAMINATIONS 2009/2010
FIRST SEMESTER EXAMINATION FOR THE DEGREE OF MASTER OF
ECONOMICS
EAE 503: MONETARY THEORY AND POLICY
DATE: FRIDAY, 4TH DECEMBER 2009 TIME: 9.00 A.M. - 12.00 P.M.
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Question One
a) Graph the money market with the Baumol-Tobin (BT) money demand. Show on the
graph the effect of a decrease in the cost of withdraws. (4 marks)
b) Explain what happens to:
i. The equilibrium interest rate. (3 marks)
ii. The real money supply (3 marks)
iii. The number of withdraws per period (3 marks)
iv. Excess reserves (3 marks)
v. Consumption velocity (3 marks)
c)Graph the money market ONLY, with money supply sensitive to interest rates. Show on the graph an increase in high powered money. Label the trapped liquidity. Where does most of the increase in H go? (4 marks)

Question Two
Suppose the Central Bank of Kenya (CBK) cares about low inflation and low unemployment. Specifically, the CBK’s objective is:

2 2
min{1/2U +1.p
t t i.e. the CBK wants to minimize squared inflation plus squared unemployment
(the CBK is twice as displeased by squared inflation versus squared unemployment).Unemployment evolves according to the Lucas Monetary misperceptions model
with k.a = 1 and ( ) te t t NR = 2 : u = 2 +p+p
a) Compute the optimal rule and the optimal discretionary policy. (9 marks)
b) Calculate the long run unemployment and inflation under both the optimal rule and discretion and compute the CBK’s long run objective for the rule and discretion. Which better achieves the CBK objective of low inflation and unemployment, the optimal rule or the optimal discretion? (6 marks)
c) Suppose expectations rise (so that unemployment is above its natural rate). Does the CBK raise or lower inflation? Why? (2 marks)

Question Three
The CBK has increasingly moved towards more transparency about changes in monetary policy. Let 2 4 and let 4.. 3 0 0 k a = and NR = p =p e = Suppose further the CBK plans to print money and increase the inflation rate to 6% in period one and then keep inflation at 8% for periods 2 and 3.
a) Suppose the CBK is transparent and credibly announces the change in policy.
Therefore , +1 +1 = te t p p so that no firms misperceive. Calculate inflationary expectations and unemployment for periods 0-3 and graph the results on the Phillips curve graph for the monetary misperceptions model. (4 marks)
b) Now suppose the CBK is not transparent and does not announce the policy,so that tet p =p +1 Calculate inflationary expectations and unemployment for periods 0-3 and graph the results on the Phillips curve graph for the monetary misperceptions model. (4 marks)
c) Is it best for the CBK to be transparent in this example? Explain briefly. (2 marks)
d) Is it best for the CBK to be transparent if the policy is to decrease inflation?
Explain briefly (you do not need to use graphs). (2 marks)

Question Four
Discuss (schematically) how monetary policy affects aggregate output through the
following channels:
i. Interest rate channel (3 marks)
ii. Credit channel (3 marks)
a. Balance sheet channel (3 marks)
b. Bank-lending channel (3 marks)
iii. Exchange rate channel (3 marks)
iv. Other Asset prices channel (3 marks)

Monetary Theory And Policy Question Paper

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