Macro Final

What type of inflation was caused by Paul Volcker’s monetary policy? Define it and list the dates that this occurred in

Disinflation-high rates in the early 80s brought inflation down but with recession

In terms of the long span of US history, what is the main difference between inflation levels before WWII and after it?

Lower before WWII

Explain (briefly) the classical and keyeseian views on the speed of price and wage adjustment

classical-rapid, keynesian-slower

List the componetns of expenditure that total up to watch GDP for an open economy

C + I + G + NX

Explain (briefly) the chain weighted methodology for real GDP accounting since the 1990s. Sumarize the basic method and how it differs from a simple base year method.

Compromise between current year and last year as base (add more for answer)

Suppose GDP= $20 trillion (with no foreign factor payments and 0 depreciation and 0 statistical discrepancy)

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Suppose corporate profits are $4 trillion (1 trillion to corp tax and $2 trillion is paid as dividends)

Let’s have G=$4 trillion (no TR and INT) and personal tax is $2 trillion and C=$15 trillion (recall X=0 and M=o, since no trade, NX=0). Sketch circular flow (with numbers). Find both nationa saving and private saving

True or False: when national savings exceeds investment expenditure there is a current account surplus and net outflows of saving to the rest of the world

True

True or False: National saving and investment match in a closed economy. However, that accoutning identity can involve a situation where investment includes some unitended inventory build-up which makes the level of investment exceed the desired amount of spending on capital goods.

True

National saving might include both of the following categories: depreciation and retained earnings by corporations

True

Suppose that real GDP for Q2 is $4 trillion and real GDP for Q3. is 4.15 What is:

a) the quarterly growth rate for Q3

b) The annualized compounded growth rate for Q3

a) .0375

b)0.159

Sketch the Labor Demand curve (with the axes labelled) and explain the method used to derive it

Sketch out an example of the labor supply decision where the income effect and the substitution effect cancel out. Use an example like the one covered, but where the wage is initally $8 per hour and 16 hour of lesiure is optimal. Put leisure on the vertical axis and then increase the wage to $10 per hour and show the new optial choice (assuming the two effects offset each other and includig the relevant indifference curves). Assume that we are doing this with a permant change in the wage, and then follow up by describing how the outcome would differ for a temporary increase in the wage

Show a diagram with labor supply and labor demand and indicate what happens when immigration increases. How will real wages, employment, and output be affected?

True or False: The unemployment rate is a measured % of the labor force (not the population)

True

True or False: The natural rate of unemployment corresponds to the total of frictional unemployment and structural unemployment

True

True or False: the participation rate corresponds to the % of the labor force who are employed rather than unemployed

False

The intertemporal optimization (with C2 on vertical axis and C1 on the horizontal axis). Assume the person has no intial wealth, but they habe period 1 income of 600 and period 2 income of $200. Also, assume interest rate is 10%. Draw a diagram where the ptimal choice is C1 = $400. Then increase the interest rate to 50% and show a new equilibrium to indicate why this person is likely to redice their saving. Make the indiffernce curves plausible and give consistent/plausible #s for the new C1 C2 choice

Show the Sd Id diagram for a loable finds and goods market equilibrium with $100 of S and I. Use slipes of 1 and -1 like we did in class and assume C=400, G=100, and T=100 in the initial situation. Then househoolds decide they want to consume $20 less at the intial interest rate. Show and explain the resulting adjustments and include the new numbers for C and I and total expenditure. Do this in the standard classical way and note the implications for the capital stock. Then mention the objection/critique economist would bring up

What was Arthur Burns famous for

Not fighting inflation with sufficient vigor or letting it perk up again in 70s

Explain why the Fed prefers to focus on PCE inflation instead of CPI inflation

Broader and avoids substitution bias or mention chian weighted

Suppose GDP= $20 trillion (with no foreign factor payments and 0 depreciation and 0 statistical discrepancy)

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Suppose corporate profits are $4 trillion (1 trillion to corp tax and $3 trillion is paid as dividends)

Let’s have G=$4 trillion (no transfers and no int) and personal tax is $2 trillion and C=$15 trillion, but $1 trillion of that is imports (no exports). Sketch circular flow (with numbers). Find both national saving and private saving

True or False: When national savings exceeds investment expenditure there is a current account deficit and net inflows of saving from the rest of the world.

False

True or False: National saving and investment match in a closed economy. However that accounting identity can involve a situation where investment inccludes some unintended inventory build-up which makes the level of investment exceed the desired anmount of spending on capital goods

True

True or False: National saving might include both of the following categories: depreciation and retained earnings by corporations

True

Show a diagram with labor supply and labor demand and indicate what happens when energy suppplies become depleted. How will real wages, employment, and output be affected?

True or False: The standard classical model of the labor market assymes that the market clears and leaves the real-world unemployment levels aside/unaddressed

True

True or false: If Helena handbasket’s home is suddenly worth three times its previous value, she is likely to supply less labor

True

True or False: the participation rate corresponds to the % of the labor force who are employed rather than unemployed

False

Show the Even Steven example of intertemporal choice for a person with 400 of income in both periods (no wealth). Put C2 on the vertical and illustrate why we know the saving response for this scenario (where they choose 400 400 initially with r=0 and then r rises to 20%). Make the indifference curve plausible and give consistent #s for C1 and C2 in the new choice tha

Explain ricadian equivalence for a lump sum tax cut or tax hike

Briefly explain how the desired capital stock is derived (with words or a diagram- your choice). Then say how each of the mentioned varable changes (below) would affect the desired capital stock

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a) An increase in the expected future MPK due to rising total factor productivity

b) An increase in the tax rate on corporate revenue

c) A decline in the user cost of capital due to lower interest rates

a) K up

b) K down

c) K up

Show a diagram for intertemporal optimization (with C2 on the vertical axis and C1 on the horizontal axis). Assume the person has no initial wealth, but they have period 1 income of 200 and expected period 2 income of $500. Also, assume the interest rate is 10%. Draw a diagram where the optimal choice is C1=$400. Then increase the interest rate to 50% and show a new equilibrium to indicate why this person is likely to increase their saving (ie borrowing less). Make the ic plausible and give consistent #s for C1 and C2 in the new choice that you label

Recall the twin deficits from chapter 5: where a rising government budget deficit usually causes a rise of the current account deficit. What was the point about the 2009 situation? Did the twin deficits move in the usual expected way? Why or why not? Explain briefly.

They did not. Bigger budget deficit but private saving rose and desireved investment fell/ State or show in diagram with Sd Id

Explain the difference between trhe private financial account and the official financial account

private financial account-private firms or people buying assets

Official financial account-central banks intervening

True or False: if there is a shift toward less saving in a large country then global interest rates will rise, but a shift toward less saving in a small country will alteral global interest rates

True

Consider the Solow model with a fixed population. Let Y=10K^.3 N^.7 and use a 25% saving rate and a 5% depreciation rate and N=10. Draw the diagram to illustrate the long run steady state and solve the steady level of K

Now sketch the diagram for the solow model to illustrate the Golden Rule level of capital on the horizontal axis. Include the output function and the depreciation function. Solve for the golden rule level of K using Y=10K^.3 N^.7 and use a 25% saving rate and a 5% depreciation rate and N=10.

Consider the Solow model with 3% population growth and 5% depreciation. what is the steady investment per worker locus? Reminder: that shows the investment per worker which is consistent with a steady state for the capital labor ratio. DO NOT solve for the steady state; just show the equation for the steady investment per worker locus (the linear line in the main diagram). Give the exact numbers.

Explain the basic methodology of the so-called Ramsey model and how it differs from the Solow model.

Saving is chosen to maximize expected lifetime utility over an infinite horizon in the Ramsey model. In Solow we just assume a saving rate

Briefly explain the classical dichotomy between real and nominal variables and relate that to the AD we talked about in chapter 7 that was based on the quantity theory equation. Show AD for that framework (including the key equation)

Explain why M1 and M2 are roughly similar now but were not in the past

Many savings accounts were re-classified in 2020 due to lifting restrictions on the # of transactions

Procyclcial or countercyclical; lagging, leading or coincident

1) industrial production

2) comumption

3) business fixed investment

4) Employment

5) Stock prices

6) Inflation

7) Unemployment

8) Money

1) Procyclical, coinciding

2) Procyclical, coinciding

3) Procyclical, coinciding

4) Procyclical, coinciding

5) Procyclical, leading

6) Procyclical, lagging

7) Countercyclical, timing unclassified

8) Procycical, leading

True or False: The Great Moderation is a term for a more stable business cycle environment in the US during the 1960s and 1970s

False

US Business Cycle Pattern: Before WWII

The worst economic contraction was the Great Depression of the 1930s

US Business Cycle Pattern: After WWII

From 1945 to 1970 there were five mild contractions \\n • **A very long expansion** (106 months, from February 1961 to December 1969) \\n • **The O P E C oil shock** of 1973 caused a sharp recession, with real G D P declining 3%, the unemployment rate rising to 9%, and inflation rising to over 10%

US Business Cycle Pattern: After The 1980s

The Long Boom ; first part of the period known as the Great Moderation \\n • From 1982 to 2001, only one brief recession, July 1990 to March 1991, not very severe \\n • Volatility of many macroeconomic variables declined sharply \\n

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The Great Recession \\n • The longest and deepest recession since the Great Depression; began in December 2007 \\n • Sluggish economic growth even after the recession ended in 2009 (**secular stagnation**)

What is the great moderation

Great moderation \\n Less volatility business cycle after early 1980’s (Long Boom) \\n • After the severe 1981–1982 recession the U.S. economy began an extended period of \\n economic growth and reduced volatility of major macroeconomic variables. (Long boom) \\n • In the mid-1980s, during the early part of the Long Boom, the volatility of many major \\n macroeconomic variables declined sharpl

What is secular stagnation

Slower demand growth that made more stimulus necessary; lower interest rates \\n • The Great Recession; began in December 2007 \\n • Fed reduced interest rates to near zero \\n • Sluggish economic growth even after the recession ended in 2009 (secular stagnation)

Show the derivation of the IS schedule: using desired saving and investment on the left and the IS in a seperate diagram on the right. Label the axes

Show the derivation of the LM using the same Money demand from my handout and using $10 as the money supply ($ amounts in trillions, but you should leave out the 000s to make it easy)

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Md=P(9.5 + .1Y - .45i) (keep the price level fixed at 1 so you can ignore it)

Sketch the resulting LM and label the Y #s for i=10 and i=8

note that i and r can be used interchangeably since P is fixed $

Show how a rise in G will shift AD for two alternative cases. On the left, to the monetarist case with a vertical LM and AD AS below it. Have a vertical AS and say whether inflation results. What is the interest elasticity of money demand? Then repeat the abalysis with a case of a modest (average) LM slope (do that one on the right side)

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Show the liquidity trap scenario with Ms and Md and then the LM with IS and FE on the right. Why is monetary poliy unable to stimulate aggregate demand? Can fiscal policy help? How does this relate to Irving Fisher’s analysis of debt defkation scenario? No speicific #’s required, but make the shapes similar to my examples and the key

Show and explain that same example I focused on in chapter 5 (with 2 diagrams) where the US and the rest of the world begin with balance trade and r=5% and then the US starts saving less

True or False: The adujustment of the BoP is closely related to the adjustment of the currency market since the BoP transaction that are credits in the US BoP accounts correspond to demand for dollars in the currency market

True

Consider the Solow model with a fixed population. Let Y=10k^.4 N^.6 and use a 25% saving rate and a 6% depreciationr ate and N=10. Draw the diagram to illustrate the long run steady state and solve for the steady state level of K

Now shetech the diagram with the Golden Rule level of capital on the

Using the same output function from #4, derive the intensive form of the output function (that you would use to find the steady state for a case with population growth). DO NOT solve for the steady state. Just show the alegraba

How does the production function in endogenous growth theory differ from the production function in the Solow model? Explain or give an example

Suppose that 1 year bonds that pay $100 at maturity are priced to yield 3%. What is the price? Show how you get it

97\.1 = 100/1.03

True or False: the expectations theory of the yield curve helps explain why 10 year bond yields are currently lower than the yield on a 2 year bond

True

True or false- Knut Wicksell proposed a more general verision of the classical loanabole funds approach that can allow a rise in saving to cause some money hoarding so that interest rates don’t fall enough to maintain expenditure at its original level.

True

Explain what the Great Moderation refers to (in US business cycle history)

Lower volatility after early 80s

Show the foundation for the IS schedule using the aggregate expendityre framework witht he 45 degree line (for a hypothetical drop of r). No particular #s but show teh AE diagram and explain the logic for how it relates to the IS

Suppose that the marginal propensity to coume is .8 and the marginal propensity to save is .2. Now imagine that G rises by $20 so that desired national saving shifts left by that much. How far to the right will the IS shift? Give the horizontal shift size for the IS schedule- no diagram needed

100

Following up on previous question. Assume that IS and LM intersected before the IS shift. Explain why financial conditions will prevent output from rising by the # you found in the previous question. What is the logic? Ignore the fe and infaltion issue to focus on is lm logic

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How much does real output rise if the LM is vertical

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How would things be different if the FED also increases the money supply just as G is going up? Describe what that does in the IS LM diagram. What would happen to inflation if the intial IS LM intersection had been consistent with the FE condition

r must rise to clear the money market as y rises so it won’t rise by 100. There is some crowding out

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0

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Lm would shift right. more demand, more inflation. If you started at FE then you het inflation that pulls LM left to restore FE at intial y

True or False- Ricardian Equivalency would mean that a big fiscal transfer (like a tax credit sent out for deposit in people’s account) does not shift IS to the right because people save it all. In that case, the 2021 covid stumbles would not cause more demand and would cause extra inflation

True

Show how you use the IS LM framwork to derive AD. Include the IS LM with the AD diagram below it. Also explain both ways of wording the logic for why there is less spending at higher prices\`

Show the RBC analysis of a negative productivity shock that is temporary. Use the classical/RBC verision of an IS LM FE (with a labor market diagram also) to show such a shock and explain how it impacts the economy in that theory. Does employment change? Is that somethig policymakers should respnd to? What happens to inflation

Inflation rises

When did real business cycle theory become an influential trend and who were some of the individuals involved?

80s Kydland, Prescott, Plosser

Consder a permanent and unexpected, positive productivity shock. Show what happens in the IS LM FE space ans assume the Fed alters the money supply to precent deflation

Tell me the basic story of the reverse causation logic for how money seems to correlate with business cycles, and then say whether Milton Friedman believed that reverse causation was the only reason for that apparent relation ship

Reverse causation according to RBC-if rising productivity is expected that might boost Md and the Fed might increase Ms to avoid either higher r or deflation. Then when productivity boosts real GDP it seems like the money supply was acause even if it wasn’t

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Friedman said money does seem to cause real growth at times. Money is non-neutral in short run especially if its an unexpected increase in Ms

Show the misperceptions model with the AD AS space and the labor market i the money wage space. Illustrate what happens if you start at potential output and AD shifts unexpectedly to the right. Show only the short run adjustment

Show the labor market diagram and explain the logic for the New Keynesian Efficiency Wage idea. Be sure to mention one or two explain of why that logic might be plausible.

Show the micro diagram for a monopolistically competitive firm that is in long run equilibrium before an aggregate demand increase occurs from macro policy. tell me why a small menu cost might lead the firm to maintain its original price (after AD increases slightly) even when a perfectly compeititve firm wouldn’t

1) excess capacity

2) MC still below P

3) Monopoly comp firms lose some customers when raising price. especially with meny cost they mught not maintain P and sell more

Explain why price stickiness in the above question is more plausible (for the short term) when we also assume the efffciency wage version of the labor market. Explain why it helps us justify using the efficiency wage model with the nomonal wage fixed (in the short-term)

Surpluss workers avaliable so money wage doesn’t rise (nor real wage) and that keeps marginal ccost and ATC from shifting upward-otherwise firms would need to hike prices

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Since p is fixed (in short term) the same nominal wage is also the same real wage to staying with the same w\* real wage is also the same money wage

True or False: the New Keynesian analysis that you explained in prev question could be plausible for a policy stimulus tat increase agg expendtire to be 20% above the full employment level opf output

Show the effect of a 4% increase in the Ms that makes real output rise 2% and unemployment fall from 5% to 3% (using 5% as the natural rate). Sketch the phillips curve based on zero expected inflation. Use 100 for both the inital P and initial Y. Include ISLMFE, AD SRAS, the labor market in the money wage space, and the phillips curve

How will things elvove if we assume that inflation expectation for the following year are based on workers anticipating a repeat of what happened in the first year. Show the AD SRAS diagram for how things will play out if the Fed does not shift Ad in year 2 even though workers are expecting Ad to shift upward again. what happens in the short-term before workers realize that the Fed is serious about disinflation.

Why is disinflation easier (in the model you just covered) if the Fed has full credibility. What would be different in your analysis from 10b if the Fed announces a zero inflation policy and everyone believes them? Show implications fro the AD SRAS diagram and the phillips curve position

Explain why labor utilization dynamics might boost productivity in the early phase of a business cycle expansion but not during the late phase of expansion

Firms keep some workers less busy during recession then they are more productive when demand picks up. Then in late phase expansion the firms hire more and lower MPN makes productivity growth lower

Explain the concept/scenario of “fiscal dominance” and why that might be more likely if secular stagnation reverses

When fiscal policy situation forces monetary policy to help keep interest rates low

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Reversal of secular stagnation means higher interest rates si politicians might change rules governing the Fed

What’s the reverse causation logiv that RBC folks pointed out?

If Md increases because firms expect productivity to rise then the Fed might boost Ms to prevent interesr rates from rusing and then there is economic growth after that

Did Friedman beleive that reverse causation was the only story for how money related to business cycles? Explain what he contributed to debate about wheather money is neuatral of non-neutral

No, he said money can cause growth and its non-neutral in the short run when its unexpected but neutral in the long-run or for antincipated increases

Sketch the labor market diagram and explain the logc for the New Keynesian Efficiency Wage idea. Be sure to mention one or two examples of why that logic might be plausible

Show the inflation targeting verision of the IS LM FE for a dyamic where 2% inflaiton and money growth proceed at the same rate so that the LM continues to intersect with the IS and FE and interest rates aren’t reduced. Indicate what happens to AS AD bs and Nd. how would you explain why nominal spending keeps risinig as the money supply grows.

First show the effect of a 4% increase in the money supply that makes real output rise 2% and unecmpoyment fall from 5% to 3% (5% as the natural rate). Sketch the phillips cirve position based on zero expected inflation. Use 100 for both the inital P and inital Y. Include IS LM FE, AD SRAS, the labor market in the money wage space, and the phiilips curve

How will things elvove if we assume that inflation expectation for the following year are based on workers anticipating a repeat of what happened in the first year. Show the AD SRAS diagram for how things will play out if the Fed does not shift Ad in year 2 even though workers are expecting Ad to shift upward again. what happens in the short-term before workers realize that the Fed is serious about disinflation.

What would you expect to happen as time passes if the Fed is determined to push unemployment below the natural rate> How would they achieve that in the first few years and what outcome would occur

The Fed keeps doing more money creation each year so inflation and expected inflation rise more with each passing year

1) Why did the Mexican Peso depreciate so much (against the US dollar) between 2005 and 2020?

Mostly because of inflation being a bit higher in Mexico during most years

2) Explain why PPP does not hold and explain what the “real exchange rate” refers to.

Asset market conditions can make a currency rise above or fall below the PPP level, but the real exchange rate refers to the relationship between the nominal rate and the price levels in both countries \n

for example if e rises from 100 yen/$ to 110 yen/$ without a change in prices that is a nominal appreciation of the $ (by 10%) and a real appreciation by 10%. But if e rose to 110 while prices in the US stayed the same and prices in Japan rose 10% it would be a nominal $ appreciation and NOT a real appreciation (since e x Pus/Pj has not changed)

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• What is PPP (purchasing power parity)? The idea that similar foreign \n and domestic goods, or baskets of goods, should have the same price \n in terms of the same currency. \n • There is some empirical evidence that PPP holds in the very long run, \n but over shorter periods PPP does not describe exchange rate \n behavior very well. \n • The price of domestic goods relative to foreign goods—equivalently, \n the number of foreign goods someone gets in exchange for one \n domestic good—is called the real exchange rate

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3) Explain why nominal rates cannot deviate too far from PPP

if the rate deviates from PPP by a large amount the country whose currency has lost value would have extremely competitive exports and that would boost demand for its currency to limit the extent of the move \n

(speculation about a bounce-back also helps but that speculation depends on faith that the country whose currency lost value isn’t on the brink of major inflationary policy)

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4) Show the forex market diagram for US $ (relative to Yen) and explain the slope logic

5) How does a depreciation impact the IS curve in our IS LM diagram (explain why using expenditure logic for the interpretation of what IS represents)

“Open Economy IS” \n • Recall that the IS shows the level of output that expenditure can support as \n a function of the interest rate \n • In a closed economy that is synonymous with desired saving and desired \n investment matching \n • But in an open economy there is a gap between desired saving and desired \n investment which corresponds to the current account \n • It is still accurate, however, to think of the IS as showing the level of output \n that desired expenditure can support

6) Explain what the BP curve represents in the Mundell Fleming model (what is the intuition for the slope?)

7) Show and explain the impact of a monetary expansion in the IS LM BP model (with floating rates)

8) Show and explain a fiscal expansion in the IS LM BP (with floating rates)

9) Show and explain what happens after a monetary expansion in the IS LM BP with a fixed ER policy

10) How did the dynamic in #9 influence a move away from fixed rates? What does sterilization refer to in \n the context of forex intervention?