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Macroeconomics 1st Edition Glenn Hubbard, Anthony Patrick O'Brien, Matthew P Rafferty - Solutions
The number of U.S. autoworkers has decreased considerably, in part due to the decline of the auto industry but also due to changes in the way that automobiles are manufactured. In light of the information presented in this chapter on European unionism, how might the strength of U.S. autoworkers’
What is a shock? Give an example of a macroeconomic shock.
An Associated Press article about sticky prices states: “That’s what analysts call it when companies slap higher prices on products and keep them there even though the rationale for the price hikes is gone.”a. Prices for goods such as cereal and toothpaste did not fall during the 2007–2009
What is an expansion? What is a recession?
Why are nominal prices and wages sticky in the short run?
Why is it costly for firms to change prices?
The price of a bottle of Coke remained constant for nearly 70 years, but the prices of other types of goods can also be very sticky. Identify at least two products that have prices that change infrequently, and explain why the companies that produce those products might choose price stickiness as a
In Chapter 7, we saw that one possible explanation for higher natural rates of unemployment in Western Europe than the United States was stronger unions. Strong unions may also increase the severity of business cycles by increasing wage stickiness. Draw a graph of the aggregate labor market in
Consider the following statement: “If all nominal wages and prices adjusted instantly, there would be no business cycle.”Do you agree with this statement? Briefly explain.
What effect would each of the following factors have on the stickiness of nominal wages and prices? Would these factors increase or decrease the severity of the business cycle? a. Grocery stores change from stamping individual prices on products to using bar codes to scan prices into a computer. b.
How does the National Bureau of Economic Research (NBER) define a recession? What data do the NBER consider when determining whether the economy is in a recession?
Suppose that potential GDP in a small country is $10,000 in year 1 and real GDP is also $10,000. Potential GDP grows at a rate of 3% per year. a. Calculate potential GDP for the next six years. b. If real GDP in year 4 is $10,500, what is the output gap? c. If real GDP in year 6 is $11,700, what is
Consider the following statement: “In a business cycle, recessions are followed by expansions. Therefore, it is not necessary to be concerned about the costs of business cycles, because they will average out.”Do you agree with this statement? Briefly explain.
Explain how each of the following workers may be permanently affected by the situation described. a. Satyajit loses his job during a recession and remains unemployed for a long period of time. b. Lena graduates from college during a recession.
Some economists believe that the severity of the 2007–2009 recessions may have permanently changed Okun’s Law. Okun’s law states that as real GDP increases by 1 percentage point relative to potential GDP, cyclical unemployment decreases by 0.5 percentage point. How might the recession have
For each of the following, define the variable and state why it is a leading, lagging, or coincident indicator.a. Average duration of unemploymentb. Stock pricesc. Personal income minus transfer paymentsd. Index of consumer expectationse. Ratio of consumer installment credit to personal income
What would each of the following tend to indicate about the state of the economy? That is, in each of these situations, is the economy likely to be headed for a recession, in a recession, headed for an expansion, or in an expansion?a. A sharp decline in real GDPb. A rise in the inflation ratec. A
Consider the following statement: “Large countries such as the United States, in which a relatively small portion of GDP comes from international trade, are not likely to be affected by business cycles in other countries.” Briefly explain whether you agree with this statement.
Discussing business cycles, an article from the Federal Reserve Bank of Dallas stated: “Volatility can also spill over into real and financial asset markets, where severe price movements can produce seemingly arbitrary redistributions of wealth.” a. What does the article mean when it says that
How might economic uncertainty resulting from business cycles affect long-term economic growth?
What has been the average duration of U.S. recessions since World War II? What has been the average duration of U.S. expansions since World War II? What factors have contributed to the moderating of recessions?
Give examples of a procyclical and a countercyclical variable. Give examples of a leading, a lagging, and a coincident indicator.
The following table shows data on the quarterly growth rate of real GDP for the U.S. economy:a. Using the rule-of-thumb definition of a recession, did this economy experience any recessions during this period? Briefly explain.b. The NBER says that a recession began during the fourth quarter of 1973
What is a multiplier effect? Give an example.
What factors affect the size of the multiplier?
One factor in the 2007–2009 recession was the decline in housing prices due to the bursting of the housing bubble. The housing industry is closely linked to many other markets and to the spending and saving decisions of households. Carefully explain some of the ways in which a decline in housing
Suppose that the federal government decides to increase purchases by $10 billion. Briefly explain why this increase in purchases is likely to have a multiplier effect. If the tax rate on personal income is relatively low, will the size of the multiplier effect be larger or smaller than if the tax
A decline in stock prices reduces household wealth and consumption spending. Estimates of U.S. stock market losses in 2008 are around $7,000 billion. a. It is estimated that the propensity to spend out of stock market wealth is relatively small. Assume that consumers spent $0.03 out of every
The costs of the Japanese earthquake and tsunami of March 2011 include the direct cost of cleanup and additional costs, such as the loss of revenues from seafood harvests, tourism, and related industries. Using the concept of multipliers, explain how this disaster may affect the Japanese economy as
In 2011, the U.S. automobile industry appeared to be recovering as the overall economy improved. Suppose, though, that the following unlikely event had occurred: Because of the severity of the 2007–2009 recessions, all U.S.-based automobile firms had closed. a. What would be the direct impact of
Draw a graph of the goods market and identify the equilibrium level of GDP. Then use your graph to show the effect of each of the following changes:a. Households become more pessimistic and decide to buy fewer new homes.b. The government increases transfer payments without changing taxes.c.
The graph on the next page shows the goods market in equilibrium at output Y1 .Then the aggregate expenditure function shifts to AE2.a. What could have caused this shift in aggregate expenditures? b. Carefully explain the process by which the economy will adjust to the new equilibrium.
For each of the following values of the marginal propensity to consume (MPC), find the value of the multiplier. Use the equation from footnote 4 on page 308 to also calculate the value of the tax multiplier for each value of the MPC.a. MPC = 0.8b. MPC = 0.75c. MPC = 0.6
Suppose that the marginal propensity to consume is 0.8. a. If the government increases spending by $100 million, what is the change in output? b. If the government increases taxes by $100 million, what is the change in output? c. If the government increases taxes by $100 million at the same time
The IS curve shows the equilibrium combinations of the real interest rate and real GDP. a. Demonstrate using graphs how the IS curve represents equilibrium in the goods market. b. Now suppose that firms become more optimistic about future profits. Show the effect on the goods market and derive the
For each of the following changes, identify (1) whether there is a shift in the IS curve or a movement along the curve, and (2) if the curve shifts, state the direction in which it shifts. a. The real interest rate increases. b. Firms become more pessimistic about future profitability. c.
Consider the following statement: “The IS curve slopes downward because a fall in short-term nominal interest rates increases the money supply and decreases investment spending.” Do you agree with this statement? Briefly explain.
The Great Depression began in the summer of 1929, but the stock market crash of October 1929 may have deepened the initial recession. The stock market crash increased the pessimism of both households and firms and decreased household wealth. a. Which component of real GDP changed as a result of the
During the 1960s, a major restructuring of the tax code decreased taxes for most people. Also during these years, the war in Vietnam required increased government purchases. a. Which components of real GDP were affected by these events? b. How did these events affect the goods market? c. Would
How might actual investment spending be different from planned investment spending?
The name of the IS curve derives from the relationship between investment and saving. a. What is the relationship between investment and saving along the IS curve? b. Why must this relationship hold?
Why does a change in autonomous expenditure lead to a larger change in real GDP?
Explain how the IS curve represents equilibrium in the goods market.
Over which interest rates does the central bank have the most control?
What are the key differences between the short-term nominal interest rate and the long-term real interest rate?
What would cause the MP curve to shift up? Down?
Briefly describe the Fed’s changes in its target interest rate from 2004 to 2008.
Show the following using graphs:a. Show how the MP curve represents equilibrium in the money market.b. Suppose that the Fed increases the target for the federal funds rate. Show the effect on the money market and derive the new MP curve.
For each of the following changes, identify (1) whether there is a shift in the MP curve or a movement along the curve, and (2) if the curve shifts, state the direction in which it shifts. a. The Fed decreases the target federal funds rate. b. Real GDP increases. c. Government purchases increase.
Consider the following statement: “Central banks control only short-term interest rates, but long-term interest rates are most important for economic activity. Therefore, monetary policy is not important in determining output.” Do you agree with this statement? Briefly explain.
How does a shift to the right of the IS curve affect the output gap and the real interest rate?
In the early 1990s, Japan’s economy experienced a number of shocks due to the bursting of bubbles in real estate and the stock market.a. Use the IS–MP model to show the economy’s equilibrium prior to the shocks.b. Now show how the shocks affected the economy. What happened to the real
In the early 1990s, Finland experienced a severe recession in which real GDP decreased by 14% and the unemployment rate increased from 3% to nearly 20%. The causes of the depression were in some ways similar to the causes of the 2007–2009 recession in the United States: Earlier financial
Suppose that a central bank wants to increase economic activity by increasing the rate of growth of the money supply.a. What does this increase in the money supply imply about the target federal funds rate?b. Show the effect in the IS–MP model and demonstrate the effect on the output gap.c. If
The effectiveness of monetary policy in changing output depends on the slope of the IS curve, which in turn depends on the responsiveness of investment and consumption to the real interest rate. The graph below shows two IS curves. Shows the case where households and firms do not increase
In a speech at the Monetary Economics Workshop of the National Bureau of Economic Research, Fed Chairman Ben Bernanke said: “With inflation expectations well anchored, a one-time increase in energy prices should not lead to a permanent increase in inflation but only to a change in relative
Problem 4.10 discussed the language that the Fed uses to describe stable inflationary expectations: the idea that expectations are “well anchored.” If expectations are adaptive, are they likely to be well anchored? Briefly explain.
The Lehman Brothers bankruptcy helped set off a wave of demand shocks around the world.a. Use the IS-MP model to show the effects of these shocks.b. Why was the Fed worried about deflation in the wake of the Lehman Brothers bankruptcy?
In the aftermath of the 2007–2009 financial crises, the Fed became concerned about deflation. a. Use the IS–MP model including the Phillips curve to show how a decrease in aggregate expenditure could cause deflation. b. What policies should the Fed pursue to attempt to prevent deflation? Use
How is the expected inflation rate measured?
What are adaptive expectations?
For each of the following scenarios, state the likely effect on the price level and whether it is cost related or demand related. a. Unions in the airline and automobile industries successfully strike for higher wages. b. Consumers decide to spend more and save less at every level of income. c. The
Proponents of supply-side policies that aim to stimulate productivity through tax cuts and work incentives argue that changes in the individual and corporate tax codes and cuts in capital gains taxes set the stage for productivity gains during the 1990s.a. What effect would an increase in
Suppose that the economy is known to be producing at potential output. In other words, the output gap is zero. a. Graph the economy’s initial equilibrium using the IS–MP model including the Phillips curve. b. Now suppose that the government increases spending due to a war. Show the effect on
Consider the following statement: “Because wages and prices are sticky, the Phillips curve relationship between inflation and the output gap is valid only when the output gap is positive.” Do you agree with this statement? Briefly explain.
Recent evidence suggests that the Phillips curve has flattened. An article in the Economist states: “A flatter Phillips curve is good news when unemployment is falling. But it also implies bad news if inflation rises significantly.” a. If firms find it difficult to raise prices, why might the
What were the three shocks that the U.S. economy experienced during the 2007–2009 period?
Why did the default-risk premium increase during 2007–2009. How did that increase affect interest rates?
How did the collapse in housing prices after 2006 alter the composition of GDP?
What was the effect of the increase in oil prices during 2008 on the Phillips curve?
China experienced many negative effects of the U.S. recession of 2007–2009. Like the United States, China was faced with higher oil prices. Unlike the U.S. case, housing prices in China did not fall. However, China’s exports fell sharply as the recession lowered incomes in the United States and
Prior to the 2007–2009 recession, China’s inflation rate appeared to be increasing. a. What would a high and increasing rate of inflation imply about China’s output gap? b. What would you expect to happen to China’s inflation rate as a result of the U.S. recession?
Some economists were concerned that the financial crisis of 2007–2009 would lead to problems with deflation. The Federal Reserve Bank of San Francisco’s Economic Letter stated: “A popular version of the well-known Phillips curve model of inflation predicts that we are on the cusp of a
Consider the following statement: “The event that caused the recession of 2007–2009 was the failure of Lehman Brothers. If Lehman Brothers had not been allowed to fail, there would have been no effect on the risk premium and thus no demand shock.” Do you agree with this statement? Briefly
This appendix demonstrates why the IS–LM model accurately represents movements in the real interest rate and the output gap during the Great Depression.a. Use the IS–LM model to show the approximate movements of real interest rates and the output gap during the 2007–2009 financial crises.b.
Explain how the LM curve represents equilibrium in the market for money.
What factors shift the LM curve?
How can the MP curve be derived from the IS–LM model?
In earlier periods, the Fed targeted the money supply. More recently, the Fed has targeted the interest rate. a. Which model best represents the United States today? Which model would you use in explaining earlier periods? b. Use the IS–LM model to explain why the Fed cannot target the money
Draw a graph showing the IS–LM model and identify the initial equilibrium.a. For each of the following changes, show the effect on the output gap and the real interest rate.i. The government increases taxes.ii. The Fed decreases the money supply.iii. Consumers experience an increase in wealth due
Consider the following statement: “Because interest rates in the real world change, it is more appropriate to use the IS–LM model than the IS–MP model.”Do you agree with this statement? Briefly explain.
Why did Congress create the Federal Reserve System?
Explain the structure of the Federal Reserve.
What is the Federal Open Market Committee (FOMC), and why is it important?
In 1913, Congress created 12 Federal Reserve districts spread over the country. a. Why did Congress divide the country into districts? b. Some argue that Fed districts should change. Why might this change make sense?
Consider the following statement: “Because the Chairman of the Fed is appointed by the president of the United States and serves a four-year term, the president controls the Fed.” Do you agree with this statement? Briefly explain.
What are the primary goals of the Fed?
The Congressional Budget Office uses 5% as its estimate of the natural rate of unemployment. Most economists estimate that the natural rate is between 5% and 6%. However, some evidence suggests that the natural rate of unemployment may have increased after the recession of 2007–2009. If the Fed
When financial markets do not function well, savers and investors waste resources, and the economy is less efficient. a. How might problems in financial markets affect employment and economic growth? b. Some argue that the Fed should not interfere in financial markets. Why is maintaining the
What does the Fed consider to be “price stability”?
Would the Fed consider zero unemployment to be a desirable goal? Explain.
How are the goals of high employment and economic growth related?
What problems can interest rate fluctuations cause?
The Fed views price stability as keeping inflation in the range of 1% to 3%.Why doesn’t the Fed target a 0% rate of inflation?
Consider the following statement: “On average, rates of unemployment in Europe are higher than rates of unemployment in the United States. Thus, the Fed must be doing a good job of maintaining high employment.”Do you agree or disagree with this statement? Explain your answer.
During the Great Depression, banks were subject to runs.a. Explain how a bank run can occur.b. How does the term structure of a bank’s assets and liabilities create the possibility of liquidity problems?c. How can a lender of last resort (usually a central bank that can lend when no other credit
Explain how the Fed uses open market operations to target the federal funds rate. Why does the value of the federal funds rate matter?
What is the discount rate? How is it different from the federal funds rate?
What is the direct effect of changes in reserve requirements?
What are the new tools of monetary policy? How do these new tools differ from the conventional tools?
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