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foundations macroeconomics

Macroeconomics 6th Edition Olivier Jean Blanchard - Solutions

An election is about to be held. Assume that expectations about inflation for the coming year (represented by et) are formed before the election. (Essentially, this assumption means that wages for the coming year are set before the election.)Moreover, Democrats and Republicans have an equal chance
5. Political expectations, inflation, and unemployment Consider a country with two political parties, Democrats and Republicans. Democrats care more about unemployment than Republicans, and Republicans care more about inflation than Democrats. When Democrats are in power, they choose an inflation
4. New Zealand rewrote the charter of its central bank in the early 1990s to make low inflation its only goal.Why would New Zealand want to do this?
3. Suppose the government amends the constitution to prevent government officials from negotiating with terrorists.What are the advantages of such a policy? What are the disadvantages?
Assume that inflation last year was 10%, and that the unemployment rate was equal to the natural rate. The Phillips curve is given by pt = pt-1 - a 1ut - un2 Assume that you can use fiscal and monetary policy to achieve any unemployment rate you want for each of the next four years. Your task is to
2. Implementing a political business cycle You are the economic adviser to a newly elected president.In four years she will face another election. Voters want a low unemployment rate and a low inflation rate. However, you believe that voting decisions are influenced heavily by the values of
1. Using the information in this chapter, label each of the following statements true, false, or uncertain. Explain briefly.a. There is so much uncertainty about the effects of monetary policy that we would be better off not using it.b. Elect a Democrat as president if you want low unemployment.c.
At the web site of the St. Louis Fed, obtain data on the monthly exchange rate between the U.S. dollar and the Canadian dollar for the same period as your data from part (a). Again, download the data into a spreadsheet. Calculate the percentage appreciation of the U.S. dollar for each month. Using
Go to the web site of the Bank of Canada (www.bankbanque-canada.ca) and obtain data on the monthly oneyear Treasury bill rate in Canada for the past 10 years.Download the data into a spreadsheet. Now go to the web site of the Federal Reserve Bank of St. Louis (research.stlouisfed.org/fred2) and
8. Exchange rates and expectations In this chapter, we emphasized that expectations have an important effect on the exchange rate. In this problem, we use data to get a sense of how large a role expectations play. Using the results in Appendix 2 at the end of the book, you can show that the
How will the expected exchange rate in this case, where devaluation is not credible, compare to your answer to part (b)? Explain in words. Given this effect on the expected exchange rate, what must happen to the domestic
Suppose the central bank announces a devaluation.The exchange rate will remain fixed, but at a new level, E, such that E, 6 E. Suppose that financial market participants believe that there will be no further devaluations and that the government will remain committed to maintaining the exchange
7. Devaluation and credibility Consider an open economy with a fixed exchange rate, E.Suppose that, initially, financial market participants believe that the government is committed to maintaining the fixed exchange rate. Let UIP stand for the uncovered interest parity condition.
6. Self-fulfilling exchange rate crises Consider an open economy with a fixed exchange rate, E.Suppose that, initially, financial market participants believe that the government is committed to the fixed exchange rate.Suddenly, however, financial market participants become fearful that the
Does the exchange rate move more in the short run than in the medium run?The answer to part (e) is yes. In this case, the short-run depreciation is greater than the medium-run depreciation. This phenomenon is called overshooting and may help to explain why the exchange rate is so variable.
Assume that after the increase in the money stock, the domestic interest rate decreases between time t and time t + n. Again assume that the foreign interest rate is unchanged. As compared to your answer to part (d), what happens to the exchange rate today (at time t)?
Exchange rate overshootinga. Suppose there is a permanent 10% increase in M in a closed economy. What is the effect on the price level in the medium run? (Hint: If you need a refresher, review the analysis in Chapter 7.)In a closed economy, we said that money was neutral because in the medium run,
Devaluation and interest rates Consider an open economy with a fixed exchange rate, E.Throughout the problem, assume that the foreign interest rate, i*, remains constant.a. Suppose that financial market participants believe that the government is committed to a fixed exchange rate. What is the
3. Nominal and real interest parity In equation (18.4), we wrote the nominal interest parity condition as it it* -Eet+1 - Et Et In Appendix 2 to this chapter, we derive a real interest parity condition. We can rewrite the real interest parity condition in a manner analogous to equation (18.4):rt
In a closed economy, how does an increase in government spending affect investment in the medium run? (Refer to Chapter 7 if you need a refresher.)
2. Consider a country operating under fixed exchange rates, with aggregate demand and aggregate supply given by equations(21.1) and (21.2).AD : Y = Y a EP P *, G, Tb AS : P = Pe 11 + m2 F a1 -Y L, zb Assume that the economy is initially in medium-run equilibrium, with a constant price level and
1. Using the information in this chapter, label each of the following statements true, false, or uncertain. Explain briefly.a. Britain’s return to the gold standard caused years of high unemployment.b. A sudden fear that a country is going to devalue may force an exchange rate crisis, even if the
8. Expected depreciation of the dollar Martin Feldstein, as mentioned at the end of Chapter 19, is one prominent economist who argues that the dollar may need to depreciate by as much as 20% to 40% in real terms to achieve a reasonable improvement in the trade balance.a. Go the web site of The
Demand for U.S. assets, the dollar, and the trade deficit This question explores how an increase in demand for U.S. assets may have slowed the depreciation of the dollar that many economists believe is warranted by the large U.S. trade deficit and the need to stimulate the demand for domestic goods
The exchange rate as an automatic stabilizer Consider an economy that suffers a fall in business confidence(which tends to reduce investment). Let UIP stand for the uncovered interest parity condition.a. Suppose the economy has a flexible exchange rate. In an IS–LM–UIP diagram, show the
Fixed exchange rates and foreign macroeconomic policy Consider a fixed exchange rate system, in which a group of countries (called follower countries) peg their currencies to the currency of one country (called the leader country). Since the currency of the leader country is not fixed against the
Flexible exchange rates and foreign macroeconomic policy.Consider an open economy with flexible exchange rates.Let UIP stand for the uncovered interest parity condition.a. In an IS–LM–UIP diagram, show the effect of an increase in foreign output, Y *, on domestic output, Y. Explain in words.b.
In this chapter, we showed that a monetary expansion in an economy operating under flexible exchange rates leads to an increase in output and a depreciation of the domestic currency.a. How does a monetary expansion (in an economy with flexible exchange rates) affect consumption and investment?b.
Consider an open economy with flexible exchange rates.Suppose output is at the natural level, but there is a trade deficit.What is the appropriate fiscal and monetary policy mix?
Using the information in this chapter, label each of the following statements true, false, or uncertain. Explain briefly.a. A fiscal expansion tends to increase net exports.b. Fiscal policy has a greater effect on output in an economy with fixed exchange rates than in an economy with flexible
When the United States began experiencing trade deficits during the 1980s, some officials in the Reagan administration argued that the trade deficits reflected attractive investment opportunities in the United States. Consider three time periods: 1981 to 1990, 1990 to 2000, and 2000 to the present.
The U.S. trade deficit, current account deficit,and investmenta. Define national saving as private saving plus the government surplus—i.e., as S + T - G. Now, using equation(19.5), describe the relation among the current account deficit, net investment income, and the difference between national
Assume that the domestic government, G, has a target level of output of 125. Assuming that the foreign government does not change G*, what is the increase in G necessary to achieve the target output in the domestic economy? Solve for net exports and the budget deficit in each country.d. Suppose
Assume that the foreign economy is characterized by the same equations as the domestic economy (with asterisks reversed). Use the two sets of equations to solve for the equilibrium output of each country. [Hint: Use the equations for the foreign economy to solve for Y * as a function of Y and
8. Policy coordination and the world economy Consider an open economy in which the real exchange rate is fixed and equal to one. Consumption, investment, government spending, and taxes are given by C = 10 + 0.8 1Y - T2, I = 10, G = 10, and T = 10 Imports and exports are given by IM = 0.3Y and X =
7. Multipliers, openness, and fiscal policy Consider an open economy characterized by the equations below.C = c0 + c11Y - T2 I = d0 + d1Y IM = m1Y X = x1Y *The parameters m1 and x1 are the propensities to import and export. Assume that the real exchange rate is fixed at a value of 1 and treat
6. Eliminating a trade deficita. Consider an economy with a trade deficit 1NX 6 02 and with output equal to its natural level. Suppose that, even though output may deviate from its natural level in the short run, it returns to its natural level in the medium run. Assume that the natural level is
5. Net exports and foreign demanda. Suppose there is an increase in foreign output. Show the effect on the domestic economy (i.e., replicate Figure 19-4). What is the effect on domestic output? On domestic net exports?b. If the interest rate remains constant, what will happen to domestic
3. A European recession and the U.S. economya. In 2010, European Union spending on U.S. goods accounted for 23% of U.S. exports (see Table 18-2), and U.S.exports amounted to 13% of U.S. GDP (see Table 18-1).What was the share of European Union spending on U.S.goods relative to U.S. GDP?b. Assume
2. Real and nominal exchange rates and inflation Using the definition of the real exchange rate (and Propositions 7 and 8 in Appendix 2 at the end of the book), you can show that 1Pt - Pt-12 Pt-1=1Et - Et-12 Et-1+ pt - p*t In words, the percentage real appreciation equals the percentage nominal
1. Using the information in this chapter, label each of the following statements true, false, or uncertain. Explain briefly.a. The current U.S. trade deficit is the result of unusually high investment, not the result of a decline in national saving.b. The national income identity implies that
8. Saving and investment throughout the world Retrieve the most recent World Economic Outlook (WEO) from the web site of the International Monetary Fund (www.imf.org).In the Statistical Appendix, find the table titled “Summary of Sources and Uses of World Saving,” which lists saving and
7. Retrieve the most recent World Economic Outlook (WEO)from the web site of the International Monetary Fund (www.imf.org). In the Statistical Appendix, find the table titled “Balances on Current Account,” which lists current account balances around the world. Use the data for the most recent
6. Retrieve the nominal exchange rates between Japan and the United States from the Federal Reserve Bank of St. Louis FRED data site. It is series AEXJPUS.a. Plot the yen versus the dollar since 1971. During which times period(s) did the yen appreciate? During which period(s) did the yen
5. The exchange rate and the labor market Suppose the domestic currency depreciates (E falls).Assume that P and P* remain constant.a. How does the nominal depreciation affect the relative price of domestic goods (i.e., the real exchange rate)?Given your answer, what effect would a nominal
4. Consider a world with three equal-sized economies (A, B, and C) and three goods (clothes, cars, and computers). Assume that consumers in all three economies want to spend an equal amount on all three goods.The value of production of each good in the three economies is given below.A B C Clothes
3. Consider two bonds, one issued in euros (:) in Germany, and one issued in dollars ($) in the United States. Assume that both government securities are one-year bonds—paying the face value of the bond one year from now. The exchange rate, E, stands at 1 dollar = 0.75 euro.The face values and
2. Consider two fictional economies, one called the domestic country and the other the foreign country. Given the transactions listed in (a) through (g), construct the balance of payments for each country. If necessary, include a statistical discrepancy.a. The domestic country purchased $100 in oil
1. Using the information in this chapter, label each of the following statements true, false, or uncertain. Explain briefly.a. If there are no statistical discrepancies, countries with current account deficits must receive net capital inflows.b. While the export ratio can be larger than one—as it
Go to the web site of the Federal Reserve Bank of St.Louis (research.stlouisfed.org/fred2/). Under “Interest Rates” and then “Treasury Constant Maturity,” obtain the data for “3-Month Constant Maturity Treasury Yield”and “5-Year Constant Maturity Treasury Yield” for each of the
Deficits and interest rates Go back and look again at Figure 1-4. There was a dramatic change in the U.S. budget position after 2000 ( from a surplus to a large and continuing deficit). This change took place well before the crisis and the election of President Obama.The change reinvigorated the
On October 24, 2005, Ben Bernanke was nominated to succeed Alan Greenspan as chairman of the Federal Reserve.Do an internet search and try to learn what happened in financial markets on the day the nomination was announced. Were financial market participants surprised by the choice? If so, was
Suppose instead that the identity of the nominee is a surprise and that financial market participants had expected the nominee to be someone who favored an even more contractionary policy than the actual nominee. Under these circumstances, what is likely to happen to the yield curve on the day of
Now suppose that instead of making an unexpected announcement, the Fed chair is required by law to retire in one year (there are limits on the term of the Fed chair), and financial market participants have been aware of this for some time.Suppose, as in part (a), that the President nominates a
7. A new Federal Reserve chairman Suppose, in a hypothetical economy, that the chairman of the Fed unexpectedly announces that he will retire in one year. At the same time, the president announces her nominee to replace the retiring Fed chair. Financial market participants expect the nominee to be
6. The Clinton deficit reduction package In 1992, the U.S. deficit was $290 billion. During the presidential campaign, the large deficit emerged as a major issue.When President Clinton won the election, deficit reduction was the first item on the new administration’s agenda.a. What does deficit
5. A new president, who promised during the campaign that she would cut taxes, has just been elected. People trust that she will keep her promise, but expect that the tax cuts will be implemented only in the future. Determine the impact of the election on current output, the current interest rate,
4. Consider the following statement. “The rational expectations assumption is unrealistic because, essentially, it amounts to the assumption that every consumer has perfect knowledge of the economy.” Discuss.
3. For each of the changes in expectations in (a) through (d), determine whether there is a shift in the IS curve, the LM curve, both curves, or neither. In each case, assume that expected current and future inflation are equal to zero and that no other exogenous variable is changing.a. a decrease
During the late 1990s, many observers claimed that the United States had transformed into a New Economy, and this justified the very high values for stock prices observed at the time.a. Discuss how the belief in the New Economy, combined with the increase in stock prices, affected consumption
Using the information in this chapter, label each of the following statements true, false, or uncertain. Explain briefly.a. Changes in the current one-year real interest rate are likely to have a much larger effect on spending than changes in expected future one-year real interest rates.b. The
Focus in on the crisis years 2008 and 2009. How does the fall in consumer sentiment from 2007 to 2008 compare to the usual variation in consumer sentiment? Why? (Hint: The bankruptcy of Lehmann Brothers occurred in September 2008.) Although disposable income per person fell from 2008 to 2009, what
Now find every year where the growth in disposable income per person is negative. Does the index of consumer sentiment rise or fall in that quarter?
Plot the change in the index of consumer sentiment against the growth rate of disposable income per person.Focus on the portion of the graph where the change in disposable income is zero. Is the value of the level of consumer sentiment the same when income is not changing?Relate your answer to part
Plot the level of the index of consumer sentiment against the growth rate of disposable income per person. Is the relationship positive?
Explain why, in the analysis of consumption, we would want to an income measure in per capita (often called per person elsewhere in the text).
Before you look at the data, can you think of any reasons to expect consumer confidence to be related to disposable income? Can you think of reasons why consumer confidence would be unrelated to disposable income?
8. The movements of consumption and investment Go to the latest Economic Report of the President (www.gpoaccess.gov/eop/) and find Table B-2 (“Real GDP”) in the Statistical Appendix. Note that you can download the statistical appendix separately in a spreadsheet which will be easier to work
What effect does uncertainty about future labor income have on saving (or borrowing) by young consumers?
If earnings during middle age turn out to be $40,000, how much should the consumer spend when she is young to guarantee consumption of at least $20,000 in each period?How does this level of consumption compare to the level you obtained for the young period in part (a)?c. Given your answer in part (
7. Saving with uncertain future income.Consider a consumer who lives for three periods: youth, middle age, and old age. When young, the consumer earns$20,000 in labor income. Earnings during middle age are uncertain;there is a 50% chance that the consumer will earn $40,000 and a 50% chance that the
6. Borrowing constraints and aggregate capital accumulation Continue with the setup from Problem 5, but suppose now that borrowing restrictions do not allow young consumers to borrow.If we call the sum of income and total financial wealth “cash on hand,” then the borrowing restriction means
5. Individual saving and aggregate capital accumulation Suppose that every consumer is born with zero financial wealth and lives for three periods: youth, middle age, and old age. Consumers work in the first two periods and retire in the last one. Their income is $5 in the first period, $25 in the
4. Suppose that at age 22, you have just finished college and have been offered a job with a starting salary of $40,000. Your salary will remain constant in real terms. However, you have also been admitted to a professional school. The school can be completed in two years. Upon graduation, you
3. A pretzel manufacturer is considering buying another pretzel-making machine that costs $100,000. The machine will depreciate by 8% per year. It will generate real profits equal to $18,000 next year, $18,000 (1 − 8%) two years from now (that is, the same real profits but adjusted for
Suppose now that at retirement, Social Security will start paying benefits each year equal to 60% of this consumer’s earnings during her last working year. Assume that benefits are not taxed. How much can she consume this year and still maintain constant consumption over her lifetime?
2. A consumer has nonhuman wealth equal to $100,000. She earns $40,000 this year and expects her salary to increase by 5%in real terms each year for the following two years. She will then retire. The real interest rate is equal to 0% and is expected to remain at 0% in the future. Labor income is
1. Using the information in this chapter, label each of the following statements true, false, or uncertain. Explain briefly.a. For a typical college student, human wealth and nonhuman wealth are approximately equal.b. Natural experiments, such as retirement, do not suggest that expectations of
11. Do a news search on the internet about the most recent Federal Open Market Committee (FOMC) meeting.a. What did the FOMC decide about the interest rate?b. What happened to stock prices on the day of the announcement?c. To what degree do you think financial market participants were surprised by
10. Use the data source found in Figure 15-1 and find the most recent information on the term structure of interest rates ranging from three months to 30 years. Term structure information can also be found in other places on the web.Is the term structure upward sloping, downward sloping, or flat?
9. The Volcker disinflation and the term structure In the late 1970s, the U.S. inflation rate reached double digits. Paul Volcker was appointed chairman of the Federal Reserve Board in 1979. Volcker was considered the right person to lead the fight against inflation. In this problem, we will use
8. The yield curve after the crisis.On November 3, 2010, The Fed Committee that sets the short-term interest rate said:“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, including low rates of resource
7. Stock prices and the risk premium Suppose a share is expected to pay a dividend of $1,000 next year, and the real value of dividend payments is expected to increase by 3% per year forever.a. What is the current price of the stock if the real interest rate is expected to remain constant at 5%? at
6. Interpreting the yield curvea. Explain why an inverted (downward-sloping) yield curve may indicate that a recession is coming.b. What does a steep yield curve imply about future inflation?
5. Money growth and the yield curve.In Chapter 14, we examined the effects of an increase in the growth rate of money on interest rates and inflation.a. Draw the path of the nominal interest rate following an increase in the growth rate of money. Suppose that the lowest point in the path is reached
4. Using the IS–LM model, determine the impact on stock prices of each of the policy changes described in (a) through (c). If the effect is ambiguous, explain what additional information would be needed to reach a conclusion.a. An unexpected expansionary monetary policy with no change in fiscal
3. Suppose that the annual interest rate this year is 5%, and financial market participants expect the annual interest rate to increase to 5.5% next year, to 6% two years from now, and to 6.5% three years from now. Determine the yield to maturity on each of the following bonds.a. A one-year bond.b.
2. Determine the yield to maturity of each of the following bonds:a. A discount bond with a face value of $1,000, a maturity of three years, and a price of $800.b. A discount bond with a face value of $1,000, a maturity of four years, and a price of $800.c. A discount bond with a face value of
1. Using the information in this chapter, label each of the following statements true, false, or uncertain. Explain briefly.a. Junk bonds are bonds nobody wants to hold.b. The price of a one-year bond decreases when the nominal one-year interest rate increases.c. Given the Fisher hypothesis, an
9. Inflation-indexed bonds Some bonds issued by the U.S. Treasury make payments indexed to inflation. These inflation-indexed bonds compensate investors for inflation. Therefore, the current interest rates on these bonds are real interest rates—interest rates in terms of goods. These interest
8. When looking at the short run in Section 14-2, we showed how an increase in nominal money growth led to higher output, a lower nominal interest rate, and a lower real interest rate.The analysis in the text (as summarized in Figure 14-5)assumed that expected inflation, e, did not change in the
7. The Fisher hypothesisa. What is the Fisher hypothesis?b. Does the experience of Latin American countries in the 1990s support or refute the Fisher hypothesis? Explain.c. Look at the figure in the Focus box on Latin America. Note that the line drawn through the scatter of points does not go
6. Approximating the price of long-term bonds The present value of an infinite stream of dollar payments of $z (that starts next year) is $z>i when the nominal interest rate, i, is constant. This formula gives the price of a consol—a bond paying a fixed nominal payment each year, forever. It is
5. Regular IRAs versus Roth IRAs You want to save $2,000 today for retirement in 40 years.You have to choose between the two plans listed in (i) and (ii).i. Pay no taxes today, put the money in an interest-yielding account, and pay taxes equal to 25% of the total amount withdrawn at retirement. (In
4. Nominal and real interest rates around the worlda. Can the nominal interest rate ever be negative? Explain.b. Can the real interest rate ever be negative? Under what circumstances can it be negative? If so, why not just hold cash instead of bonds?c. What are the effects of a negative real
3. Compute the real interest rate using the exact formula and the approximation formula for each set of assumptions listed in(a) through (c).a. i = 4%; pe = 2%b. i = 15%; pe = 11%c. i = 54%; pe = 46%
2. For which of the problems listed in (a) through (c) would you want to use real payments and real interest rates, and for which would you want to use nominal payments and nominal interest rates to compute the expected present discounted value? In each case, explain why.a. Estimating the present
1. Using the information in this chapter, label each of the following statements true, false, or uncertain. Explain briefly.a. As long as inflation remains roughly constant, the movements in the real interest rate are roughly equal to the movements in the nominal interest rate.b. If inflation turns
Go to the Web site of the Economic Report of the President(www.gpoaccess.gov/eop/) and find Table B-47. Look at the data on average hourly earnings (in nonagricultural industries) in 1982–1984 dollars (i.e., real hourly earnings).How do real hourly earnings in 1973 compare to real hourly earnings
9. Real wages The chapter has presented data on relative wages of highskill and low-skill workers. In this question, we look at the evolution of real wages.a. Based on the price-setting equation we use in the text, how should real wages change with technological progress?Explain. Has there been

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