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foundations macroeconomics

Macroeconomics 8th Edition Andrew B. Abel, Ben Bernanke, Dean Croushore - Solutions

8. In what ways is the government debt a potential burden on future generations? What is the relationship between Ricardian equivalence and the idea that government debt is a burden?
6. Give a numerical example that shows the difference between the average tax rate and the marginal tax rate on a person’s income. For a constant before-tax real wage, which type of tax rate most directly affects how wealthy a person feels? Which type of tax rate affects the reward for working an
4. What are the three main ways that fiscal policy affects the macroeconomy? Explain briefly how each channel of policy works.
3. How is government debt related to the government deficit? What factors contribute to a large change in the debt–GDP ratio?
2. Explain the difference between the overall government budget deficit, the current deficit, and the primary current deficit. Why are three deficit concepts needed?
1. What are the major components of government outlays? What are the major sources of government revenues? How does the composition of the Federal government’s outlays and revenues differ from that of state and local governments?
3. As discussed in the text, if money demand is unstable, the Fed may prefer to target interest rates rather than the money supply itself. When the Fed follows an interest-rate-targeting policy, “Fed watchers” in financial markets and the media typically look to changes in short-term interest
2. During much of the postwar period, the Fed attempted to stabilize nominal interest rates. However, during 1979–1982 the Fed under Paul Volcker greatly reduced its emphasis on interest rate stabilization to focus on fighting inflation.Calculate and graph the quarter-to-quarter change in the
1. Obtain data on currency held by the nonbank public, which is called the currency component of M1 (starting in 1959). Define “deposits” for each year since 1959 to be M2 minus currency, and define “reserves” to be the monetary base minus currency. Calculate and graph the M2 money
3. Use the LR curve to show how each of the following shocks affects output, the real interest rate, and the price level in the short run and the long run, following the Keynesian model. Draw a diagram to answer each question.a. An increased investment tax credit designed to stimulate investment
2. Suppose that the Fed were committed to following the Taylor rule, in Eq. (14.6). For each of the following types of shocks, determine whether the use of the Taylor rule would tend to be stabilizing or destabilizing, or would have an ambiguous effect, relative to a policy of leaving the money
1. How would each of the following affect the U.S. money supply? Explain.a. Banks decide to hold more excess reserves. (Excess reserves are reserves over and above what banks are legally required to hold against deposits.b. People withdraw cash from their bank accounts for Christmas shopping.c. The
4. Suppose the current price level is 149.2 and one year ago the price level was 147.3. Output is currently 12,892.5 and potential output is 13,534.2 (both in billions of 2005 dollars).a. What value of the Federal funds rate would the Fed choose if it follows the Taylor rule given by Eq. (14.6)?b.
3. When the real interest rate increases, banks have an incentive to lend a greater portion of their deposits, which reduces the reserve–deposit ratio. In particular, suppose that res = 0.4 - 2r, where res is the reserve–deposit ratio and r is the real interest rate. The currency–deposit
2.a. The money supply is $6,000,000, currency held by the public is $2,000,000, and the reserve–deposit ratio is 0.25. Find deposits, bank reserves, the monetary base, and the money multiplier.b. In a different economy, vault cash is $1,000,000, deposits by depository institutions at the central
1. The monetary base is $1,000,000. The public always holds half its money supply as currency and half as deposits. Banks hold 20% of deposits in the form of reserves. Starting with the initial creation of the monetary base that accompanies the purchase by the central bank of $1,000,000 worth of
11. How does the use of inflation targeting improve central bank credibility? What is the main disadvantage of inflation targeting?
10. Describe the Taylor rule. What are the variables that determine the recommended interest rate according to the rule? How has the rule performed historically?
9. “It is plain to see that discretion is a better way to run monetary policy than following a rule because a policy of discretion gives the central bank the ability to react to news about the economy.” What is the monetarist response to this statement? What is the more recent argument for
8. Define each of the three main tools the Fed used in the Great Recession to avoid problems caused by the zero lower bound.
7. Describe the main sources of uncertainty that affect monetary policymakers and give an example of each.
6. What are intermediate targets? How do they differ from monetary policy goals? Describe how the Fed can target the real interest rate and how the LR curve can replace the LM curve in the IS–LM diagram.
5. Besides open-market operations, what other means does the Federal Reserve have for controlling the money supply? Explain how these alternative methods work.
4. Who determines monetary policy in the United States? What role does the President play?
3. What is the effect on the monetary base of an openmarket purchase of U.S. Treasury securities? What is the effect on the money supply?
2. Define money multiplier. Discuss how actions of the public and banks can cause the money multiplier to rise or fall. Does the fact that the public and banks can affect the money multiplier imply that the central bank cannot control the money supply? Why or why not?
1. Define monetary base. How does the monetary base differ from the money supply?
3. Plot the exchange rate of the Hong Kong dollar relative to the U.S. dollar from January 1981 to the present. Was the Hong Kong dollar generally appreciating or depreciating relative to the U.S. dollar between 1981 and late 1983? What happened after 1983? Research and find an explanation for
2. Using quarterly data since 1973, graph the U.S. real exchange rate (as calculated in Exercise 1) and net exports as a fraction of GDP in the same figure. Also create a scatter plot of the same two variables. Is the theoretically predicted relationship of the real exchange rate and net exports
1. The United States left the Bretton Woods fixedexchange-rate system in stages during the early 1970s.a. Graph the U.S. nominal exchange rate from 1973 to the present. Calculate and graph the U.S. real exchange rate from 1973 to the present, using the CPI of Canada (the largest trading partner of
4. Use a diagram like that in Fig. 13.7a to analyze the effect on a country’s net exports of a beneficial supply shock that temporarily raises full-employment output by 100 per person. Assume that the basic classical model applies so that income is always at its full-employment level.a. Suppose
3. East Bubble’s main trading partner is West Bubble. To fight inflation, West Bubble undertakes a contractionary monetary policy.a. What is the effect of West Bubble’s contractionary monetary policy on East Bubble’s real exchange rate in the short run, assuming no change in East Bubble’s
2. Use the classical IS–LM model for two countries to analyze the idea that the United States is a safe haven for investment by foreigners in a global financial crisis. Assume that because of a financial crisis, the expected future marginal product of capital falls in foreign countries. Because
1. Recessions often lead to calls for protectionist measures to preserve domestic jobs. Suppose that a country that is in a recession imposes restrictions that sharply reduce the amount of goods imported by the country.a. Using the Keynesian IS–LM model, analyze the effects of import
6. (Appendix 13.B)a. For the economy described in Numerical Problem 4, find the values of all the parameters of Eqs. (13.B.1), (13.B.2), and (13.B.3). Use Eqs. (13.B.8) and (13.B.9) to derive the open-economy IS curve for this economy.b. Derive the LM curve for this economy.c. Find output, the real
5. Consider the following classical economy: AD Y = 400 + 50 M/P. AS Y = Y = 1000. This economy produces only wine, its output is measured in terms of wine, and its currency is francs.It trades with a country that produces only cheese, and the currency of that country is crowns. The real exchange
4. Consider the following Keynesian economy: Desired consumption cd = 200 + 0.6(Y - T) - 200r. Desired investment I d = 300 - 300r. Taxes T = 20 + 0.2Y. Government purchases G = 152. Net exports NX = 150 - 0.08Y - 500r. Money demand L = 0.5Y - 200r. Money supply M = 924. Fullemployment output Y =
3. Consider the following classical economy: Desired consumption cd = 300 + 0.5Y - 200r. Desired investment I d = 200 - 300r. Government purchases G = 100. Net exports NX = 150 - 0.1Y - 0.5e. Real exchange rate e = 20 + 600r. Fullemployment output Y = 900.a. What are the equilibrium values of the
2. Japan produces and exports only cameras, and Saudi Arabia produces and exports only barrels of oil. Initially, Japan exports 40 cameras to Saudi Arabia and imports 64 barrels of oil. The real exchange rate is 4 barrels of oil per camera. Neither country has any other trading partners.a.
1. West Bubble makes ordinary soap bars that are sold for 5 guilders each. East Bubble makes deluxe soap bars that are sold for 100 florins each. The real exchange rate between West and East Bubble is two ordinary soap bars per deluxe soap bar.a. What is the nominal exchange rate between the two
11. Why is a country limited in changing its money supply under a fixed-exchange-rate system? Explain how policy coordination among countries in a fixed-exchange-rate system can increase the degree to which monetary policy may be used to pursue macroeconomic goals.
10. What is the fundamental value of a currency? What does saying that a currency is overvalued mean? Why is an overvalued currency a problem? What can a country do about an overvalued currency?
7. How does the IS–LM model for an open economy differ from the IS–LM model for a closed economy? Illustrate the use of the open-economy IS–LM model in describing how a recession in one country may be transmitted to other countries.
6. Why do foreigners demand dollars in the foreign exchange market? Why do U.S. residents supply dollars to the foreign exchange market? Give two examples of changes that would lead to an increased demand for dollars and two examples of changes that would lead to an increased supply of dollars in
5. For a given real exchange rate, how are a country’s net exports affected by an increase in domestic income? An increase in foreign income? How does an increase in the domestic real interest rate affect the real exchange rate and net exports? Explain.
2. What are the two main types of exchange-rate systems? Currently, which type of system determines the values of the major currencies, such as the dollar, yen, and euro?
1. Define nominal exchange rate and real exchange rate. How are changes in the real exchange rate and the nominal exchange rate related?
13.5 Evaluate the strengths and weaknesses of different types of exchange rate systems.
13.4 Discuss the international effects of domestic macroeconomic policies.
13.3 Use the relationship between exchange rates and international trade to develop an openeconomy IS–LM model.
13.2 Use a supplyand-demand framework to explain how exchange rates are determined.
13.1 Describe real and nominal exchange rates, how they are related, and how they change over time.
3. For each month since January 1948, calculate the share of total unemployment accounted for by people unemployed for fifteen weeks or more. How is this ratio related to the business cycle (for peak and trough dates, see Table 8.1), and to the overall unemployment rate? What are the implications
2. In this exercise, you are going to examine the historical data on Okun’s Law, which we used in our discussion of the costs of unemployment. The level form of Okun’s Law in Eq. (3.5) states that the output gap, Y - Y Y , equals cyclical unemployment, u - u‾, multiplied by 2. First, get the
1. Using annual data since 1956, create scatter plots of the following variables:a. CPI inflation rate (December to December) against the average unemployment rate for the year. (Note: You may wish to use the data converter that is available on this textbook’s Web site, www.
5. To fight an ongoing 10% inflation, the government makes raising wages or prices illegal. However, the government continues to increase the money supply (and hence aggregate demand) by 10% per year. The economy starts at full-employment output, which remains constant.a. Using the Keynesian
4. Some economists have suggested that someday we will live in a “cashless society” in which all businesses (including stores) and banks will be linked to a centralized accounting system. In this system you will be able to pay for purchases directly from your bank account without using cash.
3. In this problem you are asked to show that the expectations-augmented Phillips curve (derived in the text using the extended classical model) can be derived using the Keynesian model. Consider a Keynesian economy in which full-employment output is constant, and in which the nominal money
2. Two extended classical economies (in which the misperceptions theory holds) differ only in one respect: In economy A money growth and inflation have been low and stable for many years, but in economy B money growth and inflation have fluctuated erratically between very low and very high levels.
1. Suppose that the government institutes a program to help unemployed workers learn new skills, find new jobs, and relocate as necessary to take the new jobs.a. If this program reduces structural unemployment, what is the effect on the expectations-augmented Phillips curve and the long-run
4. An economy is described by the following equations: AD Y = 4000 + 2(M/P). SRAS Y = Y + 100(P - Pe ). Okun′s law (Y - Y)/Y = -2(u - u). In this economy full-employment output Y equals 6000 and the natural unemployment rate u equals 0.05.a. Suppose that the nominal money supply has long been
3. In a certain economy the expectations-augmented Phillips curve is p = pe - 2(u - u) and u = 0.06.a. Graph the Phillips curve of this economy for an expected inflation rate of 0.10. If the Fed chooses to keep the actual inflation rate at 0.10, what will be the unemployment rate?b. An aggregate
2. Consider the following extended classical economy (in which the misperceptions theory holds): AD Y = 300 + 10(M/P). SRAS Y = Y + P - Pe . Okun′s law (Y - Y)/Y = -2(u - u). Full@employment output Y = 500. Natural unemployment rate u = 0.06.a. Suppose that the money supply M = 1000 and that the
1. Consider an economy in long-run equilibrium with an inflation rate, p, of 12% (0.12) per year and a natural unemployment rate, u, of 6% (0.06). The expectations-augmented Phillips curve is p = pe - 2(u - u). Assume that Okun’s law holds so that a 1 percentage point increase in the cyclical
10. Why does the Federal Reserve work hard to establish its credibility? What benefits might the public gain if the Federal Reserve has a great deal of credibility?
9. Discuss at least two strategies for reducing expected inflation rapidly. What are the pros and cons of these strategies?
8. What is the greatest potential cost associated with disinflation? How does the responsiveness of the public’s inflation expectations affect the size of this potential cost?
7. Give two costs of anticipated inflation and two costs of unanticipated inflation. How is the magnitude of each affected if, instead of a moderate inflation, hyperinflation occurs?
6. Why is the natural unemployment rate an important economic variable? What factors explain the changes in the natural rate over time in the United States? What government policies, if any, might be used to reduce the natural unemployment rate?
5. Why do policymakers want to keep inflation low? Who suffers when there is cyclical unemployment?
4. Can policymakers exploit the Phillips curve relationship by trading more inflation for less unemployment in the short run? In the long run? Explain both the classical and Keynesian points of view.
3. How do changes in the expected inflation rate account for the behavior of the Phillips curve in the 1960s, 1970s, and 1980s in the United States? What role do supply shocks play in explaining the behavior of the Phillips curve in the United States?
2. How does the expectations-augmented Phillips curve differ from the traditional Phillips curve? According to the theory of the expectations-augmented Phillips curve, under what conditions should the traditional Phillips curve relationship appear in the data?
1. What is the Phillips curve? Does the Phillips curve relationship hold for U.S. data? Explain.
12.5 Discuss the challenges and costs of reducing inflation
12.4 Discuss the types and costs of inflation.
12.3 Identify the costs of unemployment and discuss the natural rate of unemployment.
12.2 Discuss whether the Phillips curve offers a “menu” of inflationunemployment combinations from which policymakers can choose.
12.1 Describe the Phillips curve relationship between unemployment and inflation.
3. Working with Macroeconomic Data Exercise 1, Chapter 10, asked you to look at the cyclical behavior of total factor productivity. If you have not completed that problem, do it now and compare productivity changes with changes in the producer price index for fuels and related products and power.
2. Because of price stickiness, the Keynesian model predicts that an increase in the growth rate of money will lead to higher inflation only after some lag, when firms begin to adjust their prices. Using data since 1960, graph the inflation rate and the rate of growth of M2. Prior to 1980, is it
1. Keynesian theory predicts that expansionary fiscal policy—either higher spending or lower taxes—will raise the real interest rate. Using data since 1960, graph the Federal government budget deficit, the state-local government budget deficit (both relative to GDP), and the real interest
5. Some labor economists argue that it is useful to think of the labor market as being divided into two sectors: a primary sector, where “good” (high-paying,long-term) jobs are located, and a secondary sector, which has “bad” (low-paying, short-term) jobs. Suppose that the primary sector
4. Classical economists argue that using fiscal policy to fight a recession doesn’t make workers better off. Suppose, however, that the Keynesian model is correct. Relative to a policy of doing nothing, does an increase in government purchases that brings the economy to full employment make
3. Suppose that the Fed has a policy of increasing the money supply when it observes that the economy is in recession. However, suppose that about six months are needed for an increase in the money supply to affect aggregate demand, which is about the same amount of time needed for firms to review
2. According to the Keynesian IS–LM model, what is the effect of each of the following on output, the real interest rate, employment, and the price level? Distinguish between the short run and the long run.a. Financial deregulation allows banks to pay a higher interest rate on checking
1. According to the Keynesian IS–LM model, what is the effect of each of the following on output, the real interest rate, employment, and the price level? Distinguish between the short run and the long run.a. Increased tax incentives for investment (the tax breaks for investment are offset by
6. (Appendix 11.C) Consider the following economy. Desired consumption Cd = 325 + 0.5(Y - T) -500r. Desired investment I d = 200 - 500r. Government purchases G = 150. Taxes T = 150. Real money demand L = 0.5Y - 1000r. Money supply M = 6000. Full@employment output Y = 1000.a. Calculate the
5. (Appendix 11.A) Consider an economy in which all workers are covered by contracts that specify the nominal wage and give the employer the right to choose the amount of employment. The production function is Y = 201N, and the corresponding marginal product of labor is MPN = 10 1N . Suppose that
4. An economy is described by the following equations: Desired consumption Cd = 300 + 0.5(Y - T) - 300r. Desired investment I d = 100 - 100r. Government purchases G = 100. Taxes T = 100. Real money demand L = 0.5Y - 200r. Money supply M = 6300. Full@employment output Y = 700.a. Write the equation
3. Consider the following Keynesian closed economy: Consumption C = 388 + 0.4(Y - T) - 600r. Investment I = 352 - 400r. Government purchases G = 280. Taxes T = 300. Full@employment output Y = 1400. Nominal money supply M = 12,600. Real money demand L = 1750 + 0.75Y -8750(r + pe ). Expected
2. An economy is described by the following equations: Desired consumption Cd = 130 + 0.5(Y - T) - 500r. Desired investment I d = 100 - 500r. Government purchases G = 100. Taxes T = 100. Real money demand L = 0.5Y - 1000r. Money supply M = 1320. Full-employment output Y = 500. Assume that expected
1. A firm identifies the following relationship between the real wage it pays and the effort exerted by its workers: Real Wage Effort 8 7 10 10 12 15 14 17 16 19 18 20 The marginal product of labor for this firm is MPN = E(100 - N) 15 , where E is the effort level and N is the number of workers
10. According to the Keynesian analysis, in what two ways does an adverse supply shock reduce output? What problems do supply shocks create for Keynesian stabilization policies?
9. What does the Keynesian model predict about the cyclical behavior of average labor productivity? How does the idea of labor hoarding help bring the prediction of the model into conformity with the business cycle facts?
8. Use the Keynesian model to explain the procyclical behavior of employment, money, inflation, and investment.
7. Describe three alternative responses available to policymakers when the economy is in recession. What are the advantages and disadvantages of each strategy? Be sure to discuss the effects on employment, the price level, and the composition of output. What are some of the practical difficulties
6. In the Keynesian model, how do increased government purchases affect output and the real interest rate in the short run? In the long run? How do increased government purchases affect the composition of output in the long run?
5. What does the Keynesian model predict about monetary neutrality (both in the short run and in the long run)? Compare the Keynesian predictions about neutrality with those of the basic classical model and the extended classical model with misperceptions.
4. Define menu cost. Why might small menu costs lead to price stickiness in monopolistically competitive markets but not in perfectly competitive markets? Why can a monopolistically competitive firm profitably meet demand at its fixed price when actual demand is greater than the firm anticipated?

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