Economics



Economics

Answer # 1 (a)

Recent empirical work has suggested that in response to a positive technology shock, labor productivity rises more than output while employment shows a persistent decline. This ?nding has raised doubts concerning the relevance of the RBC model as well as the quantitative signi?cance of technology shocks as a source of aggregate ?uctuations. We show that the inability of the RBC model to ?t these stylized facts is an artifact of the closed economy assumption (Blaug, 2007).

Although inflation in the long run is ultimately determined by domestic monetary policy, globalisation — the progressive integration of more countries into international trade and financial markets — may affect how inflation moves over the business cycle: in particular, the response of inflation to changes in demand relative to supply. Since the effect of such changes on inflation is an important part of the monetary transmission mechanism, it is important for central banks to understand how globalisation affects this (Blaug, 2009). A simple way to look at the short-run relationship between demand and inflation is to plot inflation and unemployment data, since unemployment will be high when demand is low and vice versa. In the 1980s and early 1990s, there was a stable negative relationship between inflation and unemployment, in other words, lower unemployment was associated with higher inflation.

In an open economy, the ?exible price RBC model can match the negative conditional correlation between productivity and employment quite well as long as trade elasticities fall short of unity and the degree of openness is su?ciently high. The computed variance-decompositions also suggest that there is no empirical inconsistency between matching this correlation and accepting that technology shocks are the main source of variation in output. Moreover, using a low trade elasticity value does not worsen performance along any other dimensions.

In a ?exible price open economy, a positive domestic supply shock may reduce domestic employment if it associated with a more than proportional deterioration in the domestic terms of trade, that is, if trade elasticities (Dixon, 2008). A related mechanism is operational in a ?xed price, open economy. Recall that an additional component of aggregate demand, namely, net exports is present in open economies. A domestic supply shock typically requires a deterioration in the terms of trade, accomplished through the depreciation of the domestic currency. The deterioration in the domestic terms of trade induces an expenditure switching e?ect in favor of domestic output. In a su?ciently open economy, the trade e?ect could generate an increase in the demand for domestic output that might be large enough to support an increase in domestic employment (McCann, 2003).

Answer # 1 (b)

The results of my analysis suggest that a positive technology shock (an increase in the orthogonal component of the technology indicator) causes employment, total factor productivity and capital to increase. The variance decompositions suggest that changes in technology have a relatively small effect on the number of hours worked at short run horizons. However, I find that technology (especially computer technology and telecommunications ...