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Macroeconomics 1st Edition Glenn Hubbard, Anthony Patrick O'Brien, Matthew P Rafferty - Solutions
How might rational expectations make monetary policy ineffective?
Under what circumstances will demand shocks affect real GDP if expectations are rational?
Are there reasons to doubt the policy ineffectiveness proposition? Briefly explain.
Suppose that inflation has increased at an annual rate of 2% for several years. Also assume that the central bank’s target inflation rate is 2%. a. If sellers all charge $100 for their products and expectations are adaptive, what price will they charge next year, assuming that the relative demand
Brazil experienced high inflation in the late 1980s and early 1990s. To bring prices under control, the country changed its currency to a new currency unit, the real. Explain why Brazil might need a new currency in order to control prices.
Explain the difference between a rules strategy and discretionary policy.
A very simple monetary rule might be: “Increase the money supply at the rate of growth of real GDP.” a. What would be the advantages of this monetary rule? What would be the problems? b. What if the rule said, “Increase the money supply at the rate of growth of real GDP plus 2%?” Then what
Consider the following statement: “Because the business cycle is unpredictable and real-time data are usually unobtainable, monetary policy rules probably won’t be successful.”Do you agree or disagree with this statement? Explain.
Both Alan Greenspan and Ben Bernanke have claimed that monetary policy was not responsible for the housing bubble. Instead, they blame a change in the relationship between short-term interest rates and long-term mortgage rates. An article in the Economist that summarizes their positions states part
What is the Taylor rule?
How might deviation from the Taylor rule have contributed to the 2007–2009 recession?
If central banks follow the Taylor rule, how does the real interest rate change during the business cycle?
What are the primary arguments in favor of a rules approach?
What are the primary arguments in favor of a discretionary approach?
Some central banks have explicit inflation targets, while others have implicit targets. a. In the context of topics discussed in this section, what is the advantage of having an explicit target? b. What is the advantage of having an implicit target or no target at all?
Explain how the Fed may have created the Great Moderation. In what way may the Fed have contributed to the end of the Great Moderation?
Define gross federal debt held by the public.
Consider the following statement: “Because the government can always print more money, the size of the budget deficit doesn’t matter.” Do you agree with this statement? Briefly explain.
The dollar value of the U.S. public debt is the highest in U.S. history and the highest, in absolute terms, in the world. Is this fact a reason to be concerned about the debt? Briefly explain.
What is the budget deficit? What is the difference between the budget deficit and the primary budget deficit?
Use the government’s budget constraint to express the budget deficit and the primary budget deficit algebraically.
According to the chapter, when is the debt the more useful variable to consider in policymaking? When should policymakers use the deficit instead?
What is a government trust fund? How is it a liability to the government?
Why debt is usually measured using the debt to- GDP ratio rather than the absolute amount of debt?
As stated in the chapter, gross federal debt at the end of the 2010 fiscal year was $13,562 billion. Currently, interest rates are very low, but historically, interest rates on Treasury bonds have been considerably higher. Assume, for simplicity, that the government pays the same interest rate on
As stated in the chapter, the Congressional Budget Office (CBO) estimates that the federal budget deficit was $1,294 billion in 2010. For each of the interest rates given in problem 1.8, calculate the (hypothetical) primary budget deficit and the difference between the deficit and the primary
Identify each term in Equation (13.3), repeated here:
For each of the following scenarios, explain the effect on the debt-to-GDP ratio.a. The growth rate of the labor force decreases.b. The nominal interest rate on existing bonds increases.c. The money supply increases, which causes the rate of inflation to rise.d. The money supply decreases, but
On December 7, 2010, Ireland passed a budget designed to help cut the government’s budget deficit. A total of €6 billion in savings was expected to come from spending cuts. a. Can Ireland use changes in the money supply to help with its budget crisis? Briefly explain. b. Aside from spending
Consider the following statement: “The only way for a country with a budget deficit to have sustainable fiscal policy in the long run is to cut government spending.” Do you agree with this statement? Briefly explain.
According to the Economist, “It seems certain that the Federal Reserve will continue to accompany fiscal stimulus with the monetary equivalent, in the form of near-zero interest rates and further quantitative easing.”How is this monetary policy likely to affect the sustainability of fiscal
The sustainability of fiscal policy is partly a function of the GDP growth rate. In the wake of the earthquake and related tsunami in March 2011, it appears that Japan’s growth rate in the near term may be even lower than the 10-year average of 0.7%. a. If the growth rate of GDP fell to -0.5%,
What is crowding out?
Suppose that the government initially has a balanced budget. Government spending then increases, without an accompanying increase in taxes.a. Use a graph to show the effects on real interest rates and investment. Use another graph to show the effects on capital stock, labor productivity, and
In early 2011, Congress renewed the tax cuts first passed by the Bush administration in 2001 for a 2-year period. The original tax cuts were set to expire 10 years after they were first passed. a. Assume the tax cuts were lump sum tax cuts. If Ricardian equivalence holds, what should have been the
In December 2010, Ireland passed a budget designed to cut the size of the budget deficit. An article in the Economist stated: “‘everybody pays’ was the theme of Brian Lenihan, the Irish finance minister, when he presented the toughest budget in Ireland’s history on December 7th.”Deficit
Studies have shown a link between rising debt-to- GDP ratios and real interest rates. Investment is not the only category of spending that might be sensitive to interest rates. a. How might consumption be affected by rising interest rates due to a government deficit? Will all types of consumption
How can an increase in the government budget deficit lead to a change in the trade deficit?
How might budget deficits affect long-term economic growth?
Explain Ricardian equivalence.
Why are many economists skeptical about the validity of Ricardian equivalence?
The chapter opener suggests that deficits are generally a problem for countries. Based on the models presented in Section 13.3, are there circumstances in which it might be possible that deficits could increase productivity and thus long-run growth?
Use Equation (13.4), repeated below, to demonstrate how an increase in the budget deficit must increase the trade deficit if neither consumption nor investment changes. What must happen if there is an increase in the budget deficit in a closed economy?
Explain the reasons for the projected increase in the U.S. budget deficit in coming years.
Why is the current path of fiscal policy not sustainable?
List the options for making fiscal policy sustainable.
State the primary disadvantage of each option you listed in question 4.3.
The chapter states that “the CBO’s analysis ignores the effects that these policies have on the willingness of households to save and invest.” How might policies to reduce the deficit change saving and investment?
Evidence suggests that the method of deficit reduction that least reduces economic efficiency may be slower growth in transfer payments, such as Social Security and Medicare. a. If consumers believe that deficit reduction must occur in this way, how might this change the current behavior of
Consider the following statement: “Because deficit reduction is costly to the economy, governments should never run budget deficits.”Do you agree with this statement? Briefly explain.
According to Bloomberg.com, “At an Oct. 7 foreign-exchange conference in New York . . . Alan Greenspan called the budget gap ‘scary’ and said the federal government needs to cut spending on entitlements . . . ”Why does former Fed Chairman Alan Greenspan find the budget gap scary?
What do economists assume about how households and firms make decisions and respond to changes in the economy?
What is credit rationing, and how does it affect the choices of consumers and firms?
How does investment vary over time? How does consumption vary over time? What explains the different patterns of investment and consumption?
During the financial crisis of 2007–2009, credit markets “froze” when financial institutions stopped lending to many consumers and firms because it was difficult to determine who was creditworthy. a. Did credit rationing occur during 2007–2009? Briefly explain. b. How did credit rationing
One problem that became clear during the financial crisis of 2007–2009 was that lending standards allowed some borrowers to falsify information about their income and creditworthiness. a. Explain how this problem of falsifying information relates to asymmetric information. b. What would you
Consider the following statement: “A firm would never increase investment during a recession because current GDP is too low.”Do you agree with this statement? Briefly explain.
How does consumption as a percentage of GDP vary among countries?
How does the intertemporal budget constraint change when there are taxes?
For each of the following scenarios, explain the expected effect on consumption. a. Housing prices rise. b. The government increases personal income taxes. c. Uncertainty about the economy causes the desired level of savings to increase. d. A tax cut that was expected to be temporary becomes
Suppose that you expect to work for another 50 years and then live 20 years in retirement. You have no wealth, and there are no taxes. You want to smooth consumption over your lifetime, and you will earn $75,000 per year. a. Calculate consumption in each period. b. Now assume that you receive
Some economists advocate a change from an income tax to a consumption tax, such as a national sales tax. Sales tax makes consumption more expensive and so encourages households to save. How would such a change, all other things being equal, affect each of the following? a. Current consumption b.
Most students borrow to finance their college educations and repay the loans later. How might the life-cycle hypothesis help to explain this behavior?
Late 2010, Congress renewed for a two-year period the tax cuts first passed by the Bush administration. The original Bush tax cuts were set to expire in 2011, 10 years after their original passage. a. According to the theories of consumption in this chapter, what effect would you expect the
What are the three categories of consumption? Which category is the most volatile? Which category is the least volatile?
Explain Milton Friedman’s permanent income hypothesis.
Explain Franco Modigliani’s life-cycle hypothesis.
How are Friedman’s and Modigliani’s theories of consumption similar? How are these theories different?
Explain the income and substitution effects of a fall in the real interest rate.
Explain why the marginal propensity to consume out of transitory income is different from the marginal propensity to consume out of permanent income.
Why might the intertemporal consumption choices of credit-rationed households be inefficient?
For each of the following scenarios, use a graph to show how the firm’s desired capital stock would be likely to change.a. Technological change increases the productivity of capital.b. The Fed decreases interest rates (and the inflation rate stays the same).c. The real price of capital goods
Suppose that the interest rate is 5%, the depreciation rate is 8%, the real price of capital is $10, and the tax rate is 10%. a. Calculate the tax-adjusted user cost of capital. b. Calculate the tax-adjusted user cost of capital if the depreciation rate increases to 10%. c. Return to the
Cuts in capital gains taxes are often criticized as “tax cuts for the rich” because wealthy individuals are more likely to own financial investments than are poor individuals. How might cuts in capital gains taxes benefit the economy as a whole?
If the Obama administration succeeds in passing a tax reform package that eliminates short-lived tax incentives but permanently reduces tax rates on firms, what would be likely to happen to the desired capital stock, investment, and economic growth? Is your answer different for the short run versus
The recovery from the 2007–2009 financial crisis and the resulting recession was relatively slow through 2011.While there are many reasons for the slow recovery, how might the high degree of uncertainty about future economic conditions explain the slow recovery?
In 2009, the market value of most publically traded firms was lower than it was in 2006. a. Why would the market value of most firms have fallen? b. Using Tobin’s q, what would you expect to have happened to investment during this period?
During the financial crisis of 2007–2009, it became difficult for firms to get a loan, whether the loan was for short-term funding for business inventories or for larger projects. a. Explain how this increase in credit rationing affected investment. b. The Federal Reserve created special funding
The following graph shows the marginal product of capital and the user cost of capital. Assume that the economy is currently at point A, with the capital stock equal to K*1.a. Increases in the money supply when the interest rate is near 0% have the effect of lowering real interest rates but not
John Maynard Keynes described investors as having “animal spirits,” meaning that investors often make decisions based on emotion rather than logic.a. How might “animal spirits” explain the volatility of investment relative to consumption?b. Consumers may also be motivated by emotion.Why
How does a firm decide on its desired level of capital investment?
Why must a firm consider the expected marginal product of capital when choosing the desired capital level?
What is the user cost of capital?
How does a firm decide its desired level of the capital stock?
Explain how the desired capital stock determines the level of investment.
What is Tobin’s q, and how does it link financial markets to capital investment?
Explain how credit rationing, the financial accelerator, and investment are linked.
Describe how the importance of trade has changed over time as a percentage of GDP.
Describe the components of the capital account.
Which balance-of-payments account would be associated with each of the following items? a. An export of goods b. A purchase of bonds c. A gift to someone in another country d. A dividend paid from stock owned in another country
Balance-of-payments accounting always involves double entries because the inflow of goods and services is always accompanied by financial outflows and vice versa. For each of the following scenarios, show how both sides of the transaction are recorded in the balance of payments.a. A U.S. tourist
Consider the following statement: “Because the percentage of U.S. GDP accounted for by trade is much less than for many other countries, trade is not very important to the United States.”Do you agree with this statement? Briefly explain.
If every balance-of-payments entry is offset by another (opposite) flow, how is it possible for countries to have balance-of-payments surpluses or deficits? Briefly explain.
Explain why the financial account represents the reverse flow of the current account.
How is the savings–investment relationship affected by capital flows?
What is a debtor nation? A creditor nation?
Suppose that a country with a closed economy has private saving of $5 trillion and a government budget deficit of $3 trillion.a. What is the equilibrium level of investment?b. If the economy is open and has net capital inflow of $6 trillion, what is the level of investment?c. Explain how an open
Consider the following statement: “An increase in the current account deficit must be caused by an increase in imports.”Do you agree with this statement? Briefly explain.
In 2005,Hurricane Katrina hit New Orleans and the Louisiana and Texas coasts, causing damages estimated at around $81 billion, the costliest natural disaster in U.S. history. Federal government agencies spent millions of dollars on aid and rebuilding.a. What would you expect to happen to the
How was the value of the dollar determined under the Bretton Woods system?
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