Volker Hahn, Fuzhen Wang University of Konstanz

Advanced Macroeconomics I, WT 2014/15

Exam
Date: 20 February 2015, 10:00 - 11:30

You may answer in English only.

The duration of the exam is 90 minutes.
Please use only the designated white sheets for your answers.
You must not use any books, notes, etc.
If you use mathematical formulae, define the respective vari-
ables (unless the variables have been defined in the question).
Problem #1:
Various issues (16 points)
(a) Why cant capital accumulation generate sustained economic
growth in the Ramsey-Cass-Koopmans model while it can gen-
erate sustained economic growth in the AK model? (1.5 points)
(b) Consider the 2-dimensional Euclidean metric space (R2 , d)
where d defines the distance between two vectors v1 = (x1 , y1 )
and v2 = (x2 , y2 ) as
p
d(v1 , v2 ) = (x1 x2 )2 + (y1 y2 )2 .
 
2 2 1
T : R R is a mapping defined by T (v) = y, x ,
2
v = (x, y) R2 . Check whether T is a contraction mapping.
(2 points)
(c) Consider the following Bellman equation:
 
1 0
V (k) = 0max + V (k )
k [0,k ) k k0
where (0, 1) and (0, 1). Start with the initial guess
V0 (k) = 1, perform one step of value function iteration and
compute the next guess for the value function. (2 points)
(d) Define Ricardian equivalence. Why might Ricardian equiva-
lence fail when households are credit constrained? (2.5 points)
(e) Kt is the log-deviation of Kt from its steady-state level. It
is known that K t = 2t1 + 3t2 , where t are i.i.d shocks.
Plot the impulse response of K t to a one-time shock 0 = 1.
(2 points)
(f) Provide a thought-experiment to rationalize the following opti-
mality condition from the money-in-the-utility model discussed
in the lecture
1
um (ct , mt ) + uc (ct+1 , mt+1 ) = uc (ct , mt ),
t+1
where u(ct , mt ) is the instantaneous utility function, ct is real
consumption, mt is real money balances, denotes the discount
factor and t+1 is the gross inflation rate. (3 points)
(g) What is the Friedman rule? Explain intuitively why it is opti-
mal in the money-in-the-utility model discussed in the lecture.
(3 points)

2
Problem #2:
Consider the following version of the RBC model. The economy is
populated by an infinitely lived representative household whose aim
is to maximize
E t ln Ct ,
t=0

where (0, 1) denotes the discount factor and Ct is consumption.

The household is endowed with one unit of labor which it supplies
inelastically to firms. Output Yt is produced using a technology
of the form: Yt = At Kt L1
t , where Kt is the capital stock and
Lt is employment. At is total factor productivity, whose logarithm
follows an AR(1) process: ln At = ln At1 + t , where [0, 1) and
t is normally distributed with mean zero and variance 2 . Output
can be used either for consumption or investment. Capital evolves
according to: Kt+1 = (1)Kt +Yt Ct . A0 and K0 are exogenously
given. (20 points)
(a) Write down the social planners problem in sequential form.
(2 points)
(b) Write down the Bellman equation for the social planners prob-
lem. Explain the Bellman equation intuitively. (3 points)
(c) Derive the Euler equation. State the transversality condition.
Explain the Euler equation and the transversality condition
intuitively. (4 points)
(d) The consumption Euler equation from the competitive equilib-
rium reads  
1 Rt+1
= Et ,
Ct Ct+1
where Rt+1 denotes the gross real interest rate between periods
t and t + 1. Log-linearize the above equation around its non-
stochastic steady state. (2 points)
(e) Consider the same model with a different period-t utility func-
tion u(Ct , Ct1 ) = ln(Ct Ct1 ) where (0, 1) and Ct
Ct1 . For this case, answer the following questions:
Is there a monotonic relationship between the marginal
utility of consumption in period t and Ct1 ? Can you
think of a plausible interpretation for this relationship?
(2.5 points)
Write down the Bellman equation for the social planners
problem. Name the state variables explicitly. (3.5 points)

3
 Use the first order condition and the Envelope theorem to
derive the Euler equation. State the transversality condi-
tion associated with capital. (3 points)