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Macroeconomics 1st Edition Glenn Hubbard, Anthony Patrick O'Brien, Matthew P Rafferty - Solutions

Suppose that the Fed wants to reduce the federal funds rate. a. Explain how the Fed would achieve this reduction. b. If the Fed successfully lowers the federal funds rate, how would this be expected to affect banks? c. Briefly explain why the Fed might perform the same actions you described in (a),
Explain how each of the following tools allows the Fed to fine-tune its control of bank reserves: a. The ability to pay interest on reserves b. The Term Deposit Facility (TDF)
The goal of the Term Asset-Backed Securities Loan Facility (TALF) was to allow financial institutions to borrow against a variety of illiquid assets. a. Why were these assets illiquid? b. How does the ability to borrow against these assets improve financial market stability?
The FOMC currently releases a statement after each meeting, releases a summary of the meeting three weeks later, and releases a full transcript five years later. a. Some economists have argued in favor of a more rapid release of the full minutes of the meetings. Why might the Fed oppose this rapid
What interest rate does monetary policy most directly affect? How does a change in that interest rate affect other interest rates?
Suppose that expectations are not adaptive and that increases in the money supply cause the expected inflation rate to increase. a. In this case, when the Fed increases the money supply, what happens to long-term real interest rates? b. How does the link between money supply increases and expected
During the 2007–2009 financial crisis, banks faced liquidity problems, in part due to the illiquidity of some of their assets. This in turn made some banks reluctant to lend, causing problems for households and firms that needed to borrow funds, which in turn caused economic activity to
In early 2011, unrest in the Middle East caused a sharp increase in the price of oil. Suppose that the economy was below potential GDP at prior to the oil shock, as shown at point A on the following Phillips curve graph:a. If the Fed keeps the real interest rate constant, show on the graph a
Monetary policy targets the federal funds rate, a rate that only banks pay. Why does the federal funds rate have an impact on household spending?
What is the usual monetary policy response to a recession? What is the usual monetary policy response to inflation?
What challenge does a negative supply shock create for monetary policy?
What is the bank lending channel of monetary policy? What is quantitative easing?
In 1999 and early 2000, the Fed increased the target federal funds rate repeatedly, in part because it believed that the economy was overheating and that inflation would rise. The graph below shows the position of the economy prior to the Fed€™s actions.a. Explain how the Fed€™s actions
Economic activity in the United States peaked in March 2001 and then began to decline with the NASDAQ crash resulting from the collapse of the dot-com bubble. The terrorist attacks on the United States on September 11, 2001 worsened the recession.a. Use the IS–MP model to show the position of the
Not all changes in production costs are bad for the economy. During the 1990s, changes in technology lowered costs. Use the IS–MP model including the Phillips curve to analyze the situations described below.a. Suppose the Fed does not change the real interest rate. What will happen to the
What is a recognition lag, and why is it a challenge for monetary policy?
Discussing the bailouts of insurance giant AIG and the auto companies, a New York Times article stated: “Policymakers fear companies like these are so enormous and so intertwined in the fabric of the economy that their collapse would be catastrophic.”How do companies that are “too big to
The chapter opener says that Senator Richard Shelby of Alabama accused Chairman Bernanke of sitting idly by while financial problems developed, which “greatly exacerbated the crisis.” In the early 1960s, Milton Friedman made the same criticism of the Fed’s monetary policy during the Great
What is an implementation lag, and why is it a challenge for monetary policy?
What is an impact lag, and why is it a challenge for monetary policy?
Why are economic forecasts often inaccurate? Why is this challenge to monetary policy?
What is moral hazard? How does a too-big-to fail policy contribute to moral hazard?
For each of the following cases, identify the type of lag involved. a. Although changes in policy have taken place, it takes time for businesses and consumers to react to these changes. b. Data on GDP growth during a quarter is published months after the quarter has ended and is repeatedly
Economist Milton Friedman was credited with the “fool in the shower” analogy, which compares policymakers to a fool in the shower, who, thinking that the water is too cold, might turn up the hot water very fast, thus scalding himself. What was Friedman trying to suggest about economic
The rise in housing prices in 2001–2006 was a key factor in setting the stage for the financial crisis of 2007–2009. Low interest rates is one possible cause for the rise in housing prices. Because most housing is financed with long-term mortgages, small increases in mortgage rates lead to
Consider the following statement. “Because economic models cannot precisely predict the effect of policy changes, policymakers should not use them to make predictions about the economy.” Do you agree with this statement? Explain why or why not.
In what ways is the Fed independent from the rest of the federal government?
In what ways is the Fed accountable to the rest of the federal government?
Why is it desirable for a country to have an independent central bank?
In 2010, the European Central Bank (ECB) purchased bonds issued by Greece and other euro zone economies with excessive government debt. This bailout raised a number of concerns, as discussed in the Economist. “Even as the bank’s dealers were pushing cash into the bond markets of selected
It is frequently said that people “vote with their pocketbooks.” a. What monetary policies would a president who was solely interested in reelection wish to pursue? b. What risks for the economy would such monetary policies present?
How severe was the Great Depression? Use output and unemployment data to support your answer.
Consider the following statement: “Monetary policy and fiscal policy are really the same thing because they both can involve the buying and selling of U.S. Treasury securities.”Do you agree or disagree with this statement? Explain your answer.
The chapter suggests that one reason it was difficult to predict the severity of the 2007–2009 recession is that the financial crisis was not anticipated by most economists, and thus the severity of the recession was also not anticipated. a. What might the failure to anticipate the recession
What is fiscal policy? Who is responsible for conducting fiscal policy?
What is a consumption tax, and how is it different from an income tax?
Name and describe a new tool of fiscal policy used during the 2007–2009 recession.
For each of the following situations, choose a fiscal policy and explain how it could be used to correct the economic problem. a. Real GDP is above potential GDP after a stock market boom. b. The economy is in a recession due to a decline in investment spending.
In the United States, consumption taxes (such as sales taxes) are typically state rather than federal taxes. In Europe, consumption taxes are imposed nationally rather than regionally, and they are mostly far higher than U.S. consumption taxes. a. If the United States were to reduce income taxes
The United Kingdom faced a fiscal crisis during 2010 and 2011. The government had a large budget deficit, which it believed needed to be reduced. At the time, though, the United Kingdom had only barely recovered from the 2007-2009 recession. a. What fiscal policies would achieve the U.K.
How is discretionary policy different from an automatic stabilizer?
One reason given for the Bush tax cuts in 2001 was to reduce the size of the government budget surplus. a. Why might the government want to reduce the size of the budget surplus? b. Shortly after the tax cuts were passed, various changes occurred that policymakers could not have predicted, such as
Consider the following statement: “The U.S. government is running a large budget deficit, so fiscal policy must be expansionary.”Do you agree with this statement? Briefly explain.
How do automatic stabilizers work? Relate your answer to the multiplier.
What is a cyclically adjusted budget deficit or surplus? How is it used to determine whether fiscal policy is expansionary or contractionary?
Describe the pattern of cyclically adjusted deficits and surpluses in the United States since 1992.
Briefly explain whether each of the following is (1) a discretionary fiscal policy, (2) an automatic stabilizer, or (3) not a fiscal policy. a. Government spending on rebuilding highways b. Sales and purchases of government securities on the open market c. Unemployment insurance d. Proportional
As mentioned in the chapter, in 1968, the U.S. government placed a temporary 10% surcharge on personal and corporate income in an attempt to prevent the economy from overheating and causing inflation to accelerate. a. How would you describe this policy? b. Economic research has shown that consumers
Most of the programs that we think of as automatic stabilizers did not exist in 1929. How might the existence of automatic stabilizers have affected the severity of the Great Depression?
The George W. Bush administration (2001–2009) passed a variety of tax cuts. For example, the highest marginal tax rate was lowered from 39.6% to 35%. However, these tax cuts were set to expire automatically at the end of 2010. According to the New York Times, the fight in Congress over what to do
An economy can be described by the following data: C = + MPC (1 – t) Y = $1.0 trillion + 0.758(1 - 0.25) Y I = $2.0 trillion G = $3.0 trillion NX = $0.5 trillion a. Calculate the equilibrium level of real GDP. b. Suppose that the government increases purchases by $1 trillion. Calculate the
An economy has a marginal propensity to consume of 0.90. The tax rate is 0.10.a. What is the value of the multiplier?b. What would the value of the multiplier be if the tax rate increased to 0.15?c. Suppose that the government increases purchases by $2 billion in (a) and (b).What is the change in
How do automatic stabilizers affect the IS–MP graph? The Phillips curve?
How does a change in the personal tax rate affect the multiplier? How does a change in the size of the multiplier affect the economy?
Explain the three ways in which a change in the marginal income tax rate affects the economy. How are these effects different from a change in the multiplier?
As mentioned in the chapter and in problem 2.7, in 1968, the U.S. government placed a temporary 10% surcharge on personal and corporate income in an attempt to prevent the economy from overheating and inflation from accelerating. The graph below shows a possible short-run equilibrium prior to the
From 1991 to 2000, the Japanese economy grew so slowly that those years have become known as the €œLost Decade.€Nevertheless, the Japanese government increased the national sales tax in 1997 because it had become concerned about its budget deficit. As a result, real GDP decreased by 2.0% in
Section 11.1 describes the use of “new” tools of fiscal policy, as demonstrated by the Troubled Asset Relief Program (TARP). Is it possible to show the effects of TARP by using the IS–MP model? Explain.
Unemployment insurance usually expires at approximately 26 weeks. During the 2007–2009 crisis, unemployment benefits were extended for some workers. The extended benefits expired in June 2010, but Congress passed a new extension in July. Discussing this extension, an article in the Economist
How are lags different for fiscal policy than for monetary policy? How are they the same?
Consider the following statement: “Fiscal policy that involves increases in government purchases always carries a risk of crowding out private investment. Therefore, fiscal policy is not desirable because investment spending is preferable to government spending.” Do you agree with this
While it is too soon to fully determine the effects of the American Recovery and Reinvestment Act, some argue that the multiplier effects of this stimulus have been limited. a. Under what circumstances will multiplier effects be relatively large? b. As of the summer of 2010, were these
Spending multipliers are larger when the Fed keeps interest rates low. Why might the Fed choose not to keep interest rates low? Briefly explain.
What is model uncertainty, and how is it relevant to fiscal policy?
Why is the extent to which households are forward-looking important for the size of the multiplier?
Under what circumstances will multipliers be large?
How do the uncertainties involved in policymaking limit the use of fiscal policy?
During the 2007–2009 financial crises, among policymakers, the Fed was the first to respond with a reduction in short-term nominal interest rates in September 2007. Fiscal policy actions came later. Comment on the length of fiscal and monetary policy lags and why monetary action occurred first.
The size of the federal budget deficit increased sharply in 2010 due to (1) the stimulus package of 2009, (2) reduced tax collections, and (3) increased spending due to the sluggish economy. a. If households are forward-looking, what effect will increased budget deficits have on their spending and
Draw a graph of the monetary policy rule and explain how the curve would change if the central bank becomes less tolerant of deviations from the target rate of inflation.
Consider the following statement: “Because the Fed does not have an explicit inflation target, it does not follow a monetary policy rule.” Do you agree with this statement? Briefly explain.
For each of the following scenarios, state the short run effect on the AD curve. a. There is an increase in government purchases. b. Costs of production increase. c. Investors become more pessimistic. d. The central bank becomes less tolerant of deviations from the target inflation rate. e. The
For each of the scenarios described in problem 1.12, if the AD curve shifted, explain whether the shift will be temporary or permanent. In problem 1.12 for each of the following scenarios, state the short run effect on the AD curve. a. There is an increase in government purchases. b. Costs of
What does the slope of the monetary policy rule curve indicate?
How is the aggregate demand curve related to the monetary policy rule?
What factors shift the aggregate demand curve?
Explain why some shifts of the aggregate demand curve are permanent and some are temporary.
Some central banks have explicit inflation targets. Why isn’t the inflation target zero?
Why doesn’t the Fed have an explicit inflation target? Should there be an explicit target?
What is an aggregate supply curve?
What demand factors contribute to inflation? How do these factors relate to the aggregate supply curve?
What cost factors contribute to inflation? How do these factors relate to the aggregate supply curve?
For each of the following scenarios, state the short run effect on the AS curve. a. There is an increase in government spending, which causes demand and real GDP to increase. b. Nominal wages increase rapidly. c. Lower inflation is expected in the future. d. There is a change in technology that
Write two equations for the AS curve. In both cases, assume that expectations are adaptive and that the effect of supply shocks is zero. For the first equation, assume that the inflation rate is very sensitive to changes in the output gap. For the second equation, assume that it is not. Then graph
Some economists argue that the AS curve should be drawn as nonlinear, rather than as a straight line—or in other words, b is not constant. Why might inflation react differently to changes in real GDP at low levels of real GDP as compared to at high real GDP? Briefly explain.
Consider the following statement: “The supply shock inflation parameter, s,must always be positive because supply shocks always push production costs upward.”Do you agree with this statement? Briefly explain.
The Federal Reserve Bank of Cleveland has developed a model of inflation expectations. “According to the latest estimates from the Cleveland Fed model, long-term inflation expectations are still well anchored, a fact that may be important in deciding when to tighten monetary policy.” Expected
Real oil prices decreased significantly during the 1990s. The following graph shows the initial equilibrium at point A and the shift in aggregate supply due to lower oil prices:a. Identify the new equilibrium output gap and inflation rate.b. Assuming that monetary policy does not change, show on
Consider the following statement: “Because most aggregate demand shifts are temporary, they have little lasting effect on the economy, and thus there is no need for monetary or fiscal policy to correct them.”Do you agree with this statement? Briefly explain.
In early 2010, consumer prices in the United Kingdom rose above 3%, even though the economy was growing slowly. An article in the Economist commented: “This may not be stagflation, 1970sstyle; rather it is slumpflation, given that the economy is bumping along the bottom of the biggest hole dug in
How does the economy readjust to long-run equilibrium after a period of stagflation, assuming that the Fed does not change its monetary policy rule?
How is the AD–AS model different from the IS–MP model?
Draw a graph of the AD–AS model. Label the curves and axes carefully. Then show the effects of the following: a. a positive demand shock b. a positive supply shock How are the effects of these changes on the output gap different from the effects on inflation? If you observed an increase in real
In problem 2.6, you drew two different AS supply curves, based on the sensitivity of inflation to the output gap. The following graph shows a curve that is sensitive to inflation changes (AS1) and a curve that is less sensitive (AS2):a. Draw an AD curve and assume that the equilibrium point
Problem 2.9 states that, according to the Cleveland Fed, inflation expectations in 2010 were well anchored. The Making the Connection “The End of Stagflation and the Volcker Recession” discusses how the Fed may have induced a recession to reduce both current and expected inflation.a. Suppose
Even if a family chooses not to sell its home or borrow against its value, the knowledge that the value of the house is increasing makes them feel wealthier. So, a decline in housing prices, such as happened after 2006, has a negative wealth effect. Use the AD–AS model to show the short- and
Consider the following statement: “Rational expectations assumes that all people are completely rational, and because this probably is not true, this theory doesn’t help explain price behavior.” Do you agree with this statement? Briefly explain.
Consider the following statement: “Currently, interest rates are very low. Because everyone knows that the Fed will raise rates at some point, the policy will have no effect when it happens.” Do you agree with this statement? Briefly explain.
Deflation can be as great a problem for economies as inflation. Surveying 50 well-known economists in 2010, the Economist found that “the rough consensus was that in the near term, as Western economies struggle to recover, the bigger worry there is deflation.” a. Why might falling prices cause
What does it mean to say that a central bank is credible? Are all central banks credible?

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