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foundations macroeconomics
Macroeconomics Policy And Practice 1st Edition Frederic S. Mishkin - Solutions
Suppose government purchases amount to$2.5 trillion, transfer payments amount to$1 trillion, net interest payments are $0.5 trillion and tax revenue is valued at $3 trillion.a) Calculate the government deficit.b) Calculate the primary deficit.
How does the Ricardian equivalence view of the effects of tax cuts (and budget deficits) differ from the traditional view? What objections to the Ricardian equivalence view have been raised?The Government Budget
Is balancing the budget a contractionary macroeconomic policy?Budget Deficits and Inflation Budget Deficits and Ricardian Equivalence
How does a supply-side analysis of the effects of a tax cut differ from one that focuses solely on aggregate demand?
How can government increase the quantity of aggregate output demanded by changing government spending and taxes? Why does the multiplier for spending changes differ from that for tax changes?
What arguments should be considered in assessing the burden that government debt imposes on future generations?Fiscal Policy and the Economy in the Short Run
What is a budget deficit and what are the two main ways the government can finance deficit spending? Which of these methods of financing deficits does the U.S. government most commonly use?
Identify the four main categories of government spending and give an example of each.What are the government’s four main revenue sources?
Most legal systems assume that it is better not to incarcerate a guilty individual than to incarcerate an innocent person (i.e., if you are making a mistake, at least choose the least bad one). As central banks can potentially make a mistake when bursting asset-price bubbles, which one do you think
One of the possible solutions to asset-price bubbles is the enforcement of macroprudential regulation. Financial intermediaries have an incentive to constantly look for profitable opportunities, which often implies the design of new financial instruments and even the circumvention of
Describe the effects on the economy if the Federal Reserve uses monetary policy to burst a wrongfully identified asset-price bubble.
Suppose a central bank identifies an increase in lending to the floral industry. In particular, many small businesses are borrowing aggressively to import tulips. As market participants observe a sharp increase in the price of tulips, the central bank considers its actions.a) This illustrates which
According to the March 16, 2010, FOMC statement, “The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions [...] are likely to warrant exceptionally low levels of the federal funds rate for an extended
According to the Federal Reserve Act of 1913(Section 13.3), “In unusual and exigent circumstances, the Board of Governors of the Federal Reserve System, [...] may authorize any Federal reserve bank, during such periods as the said board may determine, [...] to discount for any individual,
The following figure, from the Federal Reserve Monetary Policy Report to the Congress (July 21, 2009) shows mortgage delinquency rates from 2001 to 2009 in the United States.a) Explain why mortgage delinquency rates were higher for subprime mortgages.b) Explain why adjustable rate mortgages
According to the FDIC thirty banks failed or were assisted during 2008: six were based in California, two in Florida, and five in Nevada.The New York Times reported in 2007 that Nevada (–36.1%), Florida (–30.8%), and California (–21.3%) were amongst the top five states where home sales
As the effects of the 2007–2009 financial crisis became more pervasive, legislators and policy makers debated about the role played by the Federal Reserve as a regulatory agency. While the Federal Reserve argued for more regulatory oversight of the financial system, some policy makers wanted to
The following figure, from the Federal Reserve Monetary Policy Report to the Congress (July 21, 2009) shows the gross issuance of mortgage backed securities (MBS) in the United States between 2007 and the second quarter of 2009.Comment on the drastic changes in the gross issuance of MBS in the
Suppose you are about to buy a car and ask to see a vehicle history report to check previous accidents or problems reported for that car.When you are told that this information is not available, you decide not to buy the car.a) Do you think this example illustrates an adverse selection or moral
What are the two types of asset-price bubbles?Which type poses a bigger threat to the financial system? Why?
What prevented the financial crisis of 2007–2009 from becoming a depression?
What principal-agent problems resulted from the originate-to-distribute mortgage lending model?Why the 2007–2009 Financial Crisis Did Not Lead to a Depression Policy Response to Asset-Price Bubbles
What is a credit spread? Why do credit spreads rise during financial crises?
Why does debt-deflation make financial crises worse?The Mother of All Financial Crises: The Great Depression The 2007–2009 Financial Crisis
Describe the three factors that commonly initiate financial crises and explain how each one contributes to a crisis.
How does asymmetric information help us define a financial crisis?
Microcredit programs (i.e., very small loans to the extreme poor) usually target a group of women and assign funds to them under the condition that decisions about the use of funds are made by all women in the group. How do you think this procedure will solve asymmetric information problems?
One of the main characteristics of financial deepening is that more individuals participate in the financial system: more people open checking and saving accounts, and more firms rely on financial intermediaries as a source of funds. Comment on the effect of financial deepening on a central
Many policy makers in developing countries have proposed to implement systems of deposit insurance like the one that exists in the United States. Explain why this might create more problems than solutions in the financial system of developing countries.Financial Development and Economic Growth: The
The Wall Street Journal printed the following on April 14, 2010: “Regulators say they are trying to improve transparency and reduce risk in the derivatives market” with respect to some senators’ efforts to modify current regulations. How do you think increased transparency will affect
Gustavo is a young doctor who lives in a country with a relatively inefficient legal system and (probably as a consequence of it) an inefficient financial system. When Gustavo applied for a mortgage, he found that banks(he visited many) usually required collateral for up to 300% of the amount of
In December 2001 Argentina announced it would not honor its sovereign (government issued) debt. Many investors were left holding Argentinean bonds now priced at a fraction of their recent value. A few years later Argentina announced it would pay back 25% of the face value of its debt. Comment on
Suppose you go to a bank intending to buy a certificate of deposit with your savings. Explain why you would not offer a loan to the next individual that applies for a car loan at your local bank at a higher interest rate than the bank pays on certificate of deposits (but lower than the rate the
Identify the type of asymmetric information problem in each of the following:a) A loan office requests information about your work and credit history before approving your car loan application.b) The same loan office explains that there will be a lien placed on your car title up until you pay off
Suppose a given country encourages its citizens to save 20% of their income and allocates these funds through governmentowned financial intermediaries. As a result, many government officials get mortgages to buy expensive houses (and often default on their payments). Do you think funds were
Suppose a firm has a great idea: overnight shipping. This idea can decrease costs for many businesses and therefore result in a more efficient economy. If the entrepreneurs who create this concept cannot get funds to put their idea to work, what do you think the consequences would be for the
Why do governments provide safety nets for bank depositors and what are their consequences?Financial Development and Economic Growth: The Evidence
What steps can the government take to reduce asymmetric information problems and help the financial system function more smoothly and efficiently?
Why are asymmetric information problems particularly challenging in developing countries? What does this imply about the importance of financial intermediation and the role of banks in these countries?
What is asymmetric information? What two asymmetric information problems hinder the operation of the financial system?
How does direct finance differ from indirect finance? Which form of finance is most important?
Many of the resources assigned by the January 2009 U.S. stimulus package encouraged investment in research and development of new technologies (e.g., more fuel efficient cars, wind and solar power). Assuming this policy results in positive technological change for the U.S. economy, what does
The consequences of climate change on the economy is a popular topic in the media.Suppose that a series of wildfires destroys crops in the western states at the same time a hurricane destroys refineries in the Gulf coast.a) Using aggregate demand and supply analysis, explain how output and the
In a January 9, 2010, article the Wall Street Journal reported that “inflation-adjusted wages have slumped during 2009.” Is this statement consistent with the aggregate demand and supply analysis of the recent U.S. economic crisis? Explain.
According to aggregate demand and supply analysis, what would be the effect of appointing a Federal Reserve System chairman known to have no interest in fighting inflation?
Suppose that in an effort to reduce the current federal government budget deficit, the White House decides to sharply decrease government spending. Assuming the economy is at its long-run equilibrium, carefully explain the short- and long-run consequences of this policy.
Oil prices declined in the summer of 2008, following months of increases since the winter of 2007. Considering only this fall in oil prices, explain the effect on short-run aggregate supply and long-run aggregate supply, if any
Suppose that the White House decides to sharply reduce military spending without increasing government spending in other areas.a) Comment on the effect of this measure on aggregate demand.b) Show your answer graphically.
Evaluate the accuracy of the following statement: “The recent (from December 2008 to December 2009) depreciation of the U.S. dollar had a positive effect on the U.S. aggregate demand curve.”
In his first State of the Union speech in January 2010, President Obama proposed a tax credit for small businesses and tax incentives for all businesses that invest in new plant and equipment.a) What is the anticipated effect of these proposals on aggregate demand, if any?b) Show your answer
Starting from a situation of long-run equilibrium, what are the short- and long-run effects of a permanent negative supply shock?
Starting from a situation of long-run equilibrium, what are the short- and long-run effects of a temporary negative supply shock?
Starting from a situation of long-run equilibrium, what are the short- and long-run effects of a positive demand shock?
Describe the adjustment to long-run equilibrium if an economy’s short-run equilibrium output is above potential output.Changes in Equilibrium: Aggregate Demand Shocks
What factors shift the short-run aggregate supply curve? Do any of these factors shift the long-run aggregate supply curve? Why?REVIEW QUESTIONS All questions are available in at www.myeconlab.com.Equilibrium in Aggregate Demand and Supply Analysis
Identify changes in three factors that will shift the aggregate demand curve to the right and changes in three different factors that will shift the aggregate demand curve to the left.
During the spring of 2010 Fed officials discussed the possibility of increasing interest rates as a way of fighting potential increases in expected inflation. If the public came to expect higher inflation rates in the future, what would be the effect on the short-run aggregate supply curve? Show
Internet sites that allow people to post their resumes on line reduce the cost of job search and create opportunities for individuals looking for jobs to be matched with potential employers more quickly. Assume that these uses of the Internet reduce the average amount of time people are
Although Okun’s law holds for different countries, more flexible labor markets result in a higher response of unemployment to changes in GDP. During the recent crisis real GDP decreased in the United States, Germany, and France. Considering that the U.S. labor market is more flexible than
Using the expression for the short-run aggregate supply curve obtained in the previous problem, r = 0(U - Un) + r p = pe -0.6 *U - Un = -0.75 * (Y - YP)draw the new short-run aggregate supply curve in the same graph if there is a price shock such that . Calculate inflation when output is$8, $10,
Assuming Okun’s law is given by and that the Phillips curve is given by,a) obtain the short-run aggregate supply curve if expectations are adaptive, inflation was 3% last year, and potential output is $10 trillion (assume ).b) calculate inflation when output is $8, $10, and $12 trillion and plot
Suppose Okun’s law can be expressed according to the following formula:. Assuming potential output grows at a steady rate of 2.5% and that the natural rate of unemployment remains unchanged,(Y - YP)U - Un = -0.75 *a) calculate by how much unemployment increases when real GDP decreases by one
During 2007 the U.S. economy was hit by a price shock, when the price of oil increased from around $60 per barrel to around $130 by June 2008. Whereas inflation increased during fall 2007 (from around 2.5% to 4.0%), unemployment did not change significantly (it even slightly increased during 2007).
Suppose that the expectations-augmented Phillips curve is given by. If expected inflation is 3% and the natural rate of unemployment is 5%, complete the following:a) Calculate the inflation rate according to the Phillips curve if unemployment is 4%, 5%, and 6%.b) Plot the previous points in a graph
The following graph shows combinations of inflation and unemployment rates for Canada during the period between 1970 and 2009. Do you find evidence in favor of the Phillips curve for Canada for this period?
Plot the Phillips curve for Canada using the following data. Do you find evidence in favor of the Phillips curve for Canada during this period? Explain.
What causes the short-run aggregate supply curve to shift?
Why does the short-run aggregate supply curve slope upward?Shifts in Aggregate Supply Curves
What is Okun’s Law? How does it combine with Phillips curve analysis to derive the short-run aggregate supply curve?
According to modern Phillips curve analysis, what factors determine the rate of inflation?How do changes in each factor affect the short-run Phillips curve?
According to the expectations-augmented Phillips curve, what factors determine the rate of inflation? How do changes in each factor affect the short-run Phillips curve?
What basic relationship does the long-run Phillips curve describe? Why does it differ from the short-run Phillips curve relationship?
Suppose that a plot of the values of M2 and nominal GDP for a given country over forty years shows that these two variables are very closely related. In particular, a plot of their ratio (nominal GDP/M2) yields very stable and easy to predict values. Based on this evidence, would you recommend the
What would be the effect of a stock market crash on the demand for money according to the portfolio theory approach to money demand? (Hint: Consider both the increase in stock price volatility following a market crash and the decrease in wealth of stockholders).
Consider the portfolio theory of money demand. How do you think the demand for money will be affected during a hyperinflation(i.e., monthly inflation rates in excess of 50%)?
Suppose a given country experienced low and stable inflation rates for quite some time, but then inflation picked up and over the past decade has been relatively high and quite unpredictable. Explain how this new inflationary environment would affect the demand for money according to the portfolio
Explain how the following events will affect the demand for money according to the portfolio theory approach to money demand:a) The economy experiences a business cycle contraction.b) Brokerage fees decline, making bond transactions cheaper.
Plot the values of velocity using data from the previous exercise and comment on the volatility (i.e., fluctuations) of velocity.
Suppose the liquidity preference function is given by According to the following table, calculate velocity using Equation 2:L(i, Y) = Y 8 - 1,000i
In many countries people hold money as a cushion against unexpected needs arising from a variety of potential scenarios (e.g., banking crises, natural disasters, health problems, unemployment, etc.) that are not usually covered by insurance markets. Explain the effect of such behavior on the
The use of some payment technologies requires some infrastructure (e.g., merchants need to have access to credit card swiping machines). In most developing countries, this infrastructure is either nonexistent or very costly. Everything else the same, would you expect the transaction component of
Suppose a new “payment technology” allows individuals to make payments using U.S.Treasury bonds (i.e., U.S. Treasury bonds are immediately cashed when needed to make a payment and that balance is transferred to the payee). How do you think this payment technology would affect the transaction
What evidence is used to assess the stability of the money demand function? What does the evidence suggest about the stability of money demand and how has this affected monetary policy making?
According to the portfolio theory of money demand, what are the four factors that determine money demand? What changes in these can increase the demand for money?
What three motives for holding money did Keynes consider in his liquidity preference theory of the demand for real money balances?Based on these motives, what variables did he think determined the demand for money?
Consider the money market. Suppose that the U.S. economy finally recovers from the 2007 crisis and aggregate output increases. Describe the effect on the interest rate if the Federal Reserve decides to increase the money supply at the same time that aggregate output increases.
Assuming the demand for real money balances is given by .a) Find the equilibrium interest rate if the money supply is $1,700 billion and output equals $12,900 billion.b) Find the new equilibrium interest rate if the money supply is $1,700 billion and output increases to $13,800 billion.c) Plot both
Suppose the economy experiences a contraction in aggregate output. How would this event affect the demand curve for real money balances? On the same graph, draw the original and the new demand curve, if necessary.Md P = 12,900 6 -150i Md P = Y 6 -150i
Assume that the demand for real money balances is given by (an interest rate of 2% enters this formula as 2).Suppose that Y = 12,900 billion, so that(in billions of $).a) Calculate the demand for real money balances if the interest rate is 4%, 3%, and 1%respectively.b) Plot these points on a graph
Suppose that the U.S. economy does not recover from the 2007 contraction until 2012, when a new Fed chair is appointed. Suppose his or her approach to monetary policy can be summarized by the following statement: “I care only about increasing employment;inflation has been at very low levels for
What would be the effect of an increase in U.S.net exports on the aggregate demand curve?Would an increase in net exports affect the monetary policy curve? Explain why or why not.r = 1.5 + 0.75 p
Suppose the monetary policy curve is and that the IS curve is Y = 13 – r.a) Find the expression for the aggregate demand curve.b) Calculate aggregate output when the inflation rate is 2%, 3% and 4%.c) Plot the aggregate demand curve and identify the previous three points.
Assume now that the monetary policy curve is .a) Does the new monetary policy curve represent an autonomous tightening or loosening of monetary policy?b) Plot the new monetary policy curve on the same graph as in the previous problem.
Refer to the monetary policy curve described in Problem
Assume the monetary policy curve is given by.a) Calculate the real interest rate when the inflation rate is 2%, 3%, and 4%.b) Plot the monetary policy curve and identify the previous points.r = 1.5 + 0.75 p
What are open market operations? How does the Fed use these to increase or decrease the money supply?
In Keynes’s liquidity preference theory, what variables determine the demand for real money balances? How does the demand for real money balances respond to changes in each of these variables?
How does an autonomous tightening or easing of monetary policy by the Fed affect the aggregate demand curve?The Money Market and Interest Rates
What is the aggregate demand curve? Why does it slope downward?
How does an autonomous tightening or an easing of monetary policy by the Fed affect the MP curve?
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