Macroeconomics 11th Edition Rudiger Dornbusch, Stanley Fisher, Richard Startz - Solutions

1. What role do financial markets play in the economy? Why do we, as macroeconomists, study them?
1. Check the Federal Reserve Board’s semiannual monetary policy reports to the Congress(www.federalreserve.gov/boarddocs/hh). In these reports, which are published every year in February and July, the Federal Reserve Board members provide economic performance forecasts.Using this information,
5.* Suppose that, as the chairman of the Fed, you decided to “put policy on automatic pilot” and require that monetary policy follow an established rule. When might each of the following two rules be appropriate? ( a ) Maintain a constant interest rate. ( b ) Maintain a constant money
4. Suppose that you knew that the multiplier for government spending was between 1 and 2.5 but that its effects ended in the period in which spending was increased. How would you run fiscal policy if GDP would, without policy, behave as in problem 1?
3. Life has become yet more complicated. Government spending works with a distributed lag.Now when $1 billion is spent today, GDP increases by $1 billion this period and $1.5 billion next period.a. What happens to the path of GDP if government spending rises enough this period to put GDP back to
2. The basic facts about the path of GDP are as in problem 1. But there is now a one-period outside lag for government spending. Decisions to spend today are translated into actual spending only tomorrow. The multiplier for government spending is still 2 in the period that the spending takes
1. Suppose that GDP is $40 billion below its potential level. It is expected that next-period GDP will be $20 billion below potential and that two periods from now it will be back at its potential level. You are told that the multiplier for government spending is 2 and that the effects of the
9. How does nominal GDP targeting differ from real GDP targeting? Why is real GDP targeting the riskier of the two strategies?Technical
8. What is dynamic inconsistency? Explain intuitively how it might arise in the case of the short-run tradeoff between inflation and unemployment.
7. Evaluate the arguments for a constant-growth-rate rule for money.
6. Evaluate the argument that monetary policy should be determined by a rule rather than discretion.How about fiscal policy?
5.a. What is an econometric model?b. How might one be used?c. There is always some uncertainty with respect to predictions based on such models.Why? What is the source of this uncertainty?
4. Which would you recommend be used to offset the effect of a temporary shock to output—fiscal or monetary policy? Why?
3.a. What is an outside lag?b. Why does it generally take the form of a distributed lag?c. Which has the smaller outside lag—fiscal or monetary policy?
2.a. What is an inside lag?b. We can divide inside lags into three smaller, sequential lags. What are these, and in what order do they occur?c. Which has the smaller inside lag—fiscal or monetary policy? Why?d. What is the inside lag for automatic stabilizers?
1. * Suppose there was a small, negative shock to demand. You—a policymaker—have a stack of papers in front of you detailing the magnitude of the shock and its devastating effects on the people of your country. You are tempted to use an active policy to offset these effects. Your advisers have
2. Box 16-5 and Table 1 investigate U.S. monetary policy during the 1990–1991 recession. In this exercise you will take a look at the monetary policy conducted by the Federal Reserve during the 2001 recession. Go to http://research.stlouisfed.org/fred2 and, using the search bar, find data on
1. Go to www.federalreserve.gov/FOMC/default.htm, the official website of the Federal Open Market Committee (FOMC) of the Federal Reserve Board. Click on the “Meeting Calendars, Statements, and Minutes” tab and choose the link to one of the most recent statements from FOMC meetings. What are
4. You, as chairman of the Fed (congratulations), are considering whether the monetary base or the interest rate should be used as a target. What information do you need to have to make an informed decision? When would each be a good (or bad!) choice?
3. A proposal for “100 percent banking” involves a reserve ratio of unity. Such a scheme has been proposed for the United States in order to enhance the Fed’s control over the money supply.a. Indicate why such a scheme would help monetary control.b. Indicate what bank balance sheets would
2. When the Fed buys or sells gold or foreign exchange, it automatically offsets, or sterilizes, the impact of these operations on the monetary base by compensating open market operations.What it does is to buy gold and at the same time sell bonds from its portfolio. Show the effects on the Fed
1. Show how an open market sale affects the Fed’s balance sheet and also the balance sheet of the commercial bank of the purchaser of the bond sold by the Fed.
8. Why might the Fed choose intermediate targets for its monetary policy, as opposed to directly pursuing its ultimate targets? What are the benefits and the dangers of using these intermediate targets?Technical
7. What might be the danger in using interest rates as targets for monetary policy when credit rationing is taking place?
6. Categorize each of the following as either an ultimate or intermediate target or an instrument of monetary policy:a. Nominal GDPb. The discount ratec. The monetary based. M 1e. The Treasury bill ratef. The unemployment rate
5.a. Why does the Fed not stick more closely to its target paths for money?b. What are the dangers of targeting nominal interest rates?
4.a. What is a bank run?b. Why might one occur?c. If the Fed took no action in the face of a bank run, what would be the effects on the money supply and on the money multiplier?d. How does the existence of the FDIC help prevent this problem?
3. Under what circumstances should the Fed conduct monetary policy by targeting mainly (a)interest rates or (b) the money stock?
2. Can the Fed affect the currency-deposit ratio?
1. The Fed wants to increase the money supply. What are the main instruments available to it, and how can each, specifically, increase the money supply? ( Hint: There are three.)
2. Is there today in real terms more U.S. currency outstanding per capita than 30 years ago? To answer this question, go to http://research.stlouisfed.org/fred2 and get the data in order to fill in the first three columns of the table. To get the currency data, click on “Monetary Aggregates,”
1. The chapter reviewed the different measures of money stock ( M 1 and M 2). You can use any of these money stock measures in order to determine the velocity of money. What is the relationship between M 1 velocity and M 2 velocity? Which is the largest and which is the smallest?Go to
4. *a. Determine the optimal strategy for cash management for a person who earns $1,600 per month, can earn .5 percent interest per month in a savings account, and has a transaction cost of $1. ( Hint: Integer constraints matter here.)b. What is the individual’s average cash balance?c. Suppose
3. * The transactions demand-for-money model can also be applied to firms. Suppose a firm sells steadily during the month and has to pay its workers at the end of the month. Explain how the firm would determine its money holdings.
2.a. Is velocity high or low relative to trend during recessions? Why?b. How can the Fed influence velocity?
1. Evaluate the effects of the following changes on the demand for M 1 and M 2. Which of the functions of money do they relate to?a. “Instant-cash” machines that allow 24-hour withdrawals from savings accounts at banks.b. The employment of more tellers at your bank.c. An increase in
7. “Muggers favor deflation.” Comment.Technical
6. The demand for nominal balances rises with the price level. At the same time, inflation causes the real demand to fall. Explain how these two assertions can both be correct.
5. Explain the concept of the opportunity cost of holding money.
4. Discuss the various factors that go into an individual’s decision regarding how many traveler’s checks to take on a vacation.
3. Do you think credit card credit limits should be counted in the money stock? Why or why not?
2. To what extent would it be possible to design a society in which there was no money? What would the problems be? Could currency at least be eliminated? How? (Lest all this seem too unworldly, you should know that some people are beginning to talk of a “cashless economy”in this century.)
1. What is money, and why does anyone want it?
2. Figure 14-7 illustrates the relationship between mortgage interest rates and the share of residential investment in GDP. Another way of looking at the same relationship is to take housing starts instead of the share of residential investment.a. Go to http://research.stlouisfed.org/fred2 . Click
1. We have seen that investment spending constitutes about 13 percent of aggregate demand(GDP) in the United States. Are other countries consistently investing more than 13 percent of their output?a. Go to the Statistical Data Warehouse of the European Central Bank (
7. From 1947 through 1991, the average annual return to holding common stocks was 7 percent while the average annual percentage growth in business fixed investment was 3.5 percent.From 1992 through 1999, the average annual return to holding common stocks was 16 percent and the average annual
6. ( Optional ) For this question use the Cobb-Douglas production function and the corresponding desired capital stock given by K * g ( rc , Y ) Y rc . Assume that .3, Y $5 trillion, and rc .12.a. Calculate the desired capital stock, K *.b. Now suppose that Y is expected to rise to
5. Given the following information, calculate Tobin’s q statistic: Let’s suppose that a company has one million outstanding shares of stock, each valued at $25. Let us suppose also that the replacement cost of its physical capital stock is $18 million.a. Should this firm invest (net) in more
4.a. Explain how final sales and output can differ.b. In Figure 14-10 , point out periods of planned and unplanned inventory investment and drawing down.c. During a period of slow but steady growth, how would you expect final sales and output to be related? Explain. Draw a hypothetical figure like
3. Suppose that an explicitly temporary tax credit is enacted. The tax credit is at the rate of 10 percent and lasts only one year.a. What is the effect of this tax measure on investment in the long run (say, after four or five years)?b. What is the effect in the current year and in the following
2. The cash flows for an investment project are listed below. The firm will invest if the present value of the cash flows is positive.Year 1 Year 2 Year 3−200 100 120 Should the firm undertake this project:a. If the interest rate is 5 percent?b. If the interest rate is 10 percent?
1. Describe how a car rental agency would calculate the price at which it rents cars, and relate your description to the equation for rental cost given in the text.
13. In Chapter 5 you learned that when the aggregate supply curve is vertical, monetary policy has no effect on the real interest rate. Give two reasons why monetary policy might still affect investment even if it does not affect the interest rate.Technical
12. Why should (or shouldn’t) policymakers be concerned about the relatively low levels of U.S.investment that have prevailed in the last decade?
11. In the 1990–1991 recession, the inventory-sales ratio did not rise appreciably. How do you explain this fact?
10. Can changes in inventories predict movements in the business cycle? Why does it matter whether these changes are planned or unplanned?
9. What is the relationship between the accelerator model of inventory investment and the flexible accelerator model of capital accumulation?
8.a. Explain why the housing market usually prospers when the (real) mortgage rates are low.b. In some states, usury laws prohibit (nominal) mortgage rates in excess of a legal maximum.Explain how this could lead to an exception to the conclusion in ( a ).
7.a. Give at least two reasons why higher profits may increase the rate of investment.b. Explain why lenders may ration the quantity of credit rather than merely charge higher interest rates to more risky borrowers.
6. The number of small firms in the U.S. economy has grown substantially over the last decade.If small firms do, indeed, encounter more credit rationing than large firms, what effect might this have on output fluctuations (business cycles) in the United States?
5. According to the description of business fixed investment in this chapter, how would you expect a firm’s investment decisions to be affected by a sudden increase in the demand for its product? What factors would determine the speed of its reaction?
4. The model of business fixed investment studied in Section 14-1 examines the benefits and costs to firms of owning capital goods. Its basic conclusion is that firms will increase their capital stock as long as the marginal product of their capital exceeds the marginal cost. What is Tobin’s q ,
3. If a firm invests out of retained profits rather than borrowed funds, will its investment decisions still be affected by the changes in the interest rate? Explain.
2. What effect has the recent shift toward investment in high-tech capital goods had on the rate of depreciation? Do you think there is a rate of depreciation associated with the stock of human capital?
1. If an economy has achieved its desired capital stock and wishes merely to maintain it, should any investment occur? If not, why not? If so, how much?
1. Go to www.bea.gov and click on “Personal Income and Outlays,” and then on “National Income and Product Accounts Tables.” Click on “List of All NIPA Tables” and scroll down to“Section 5—Saving and Investment.” Select Table 5.1 (Saving and Investment) and download data for gross
5. Let’s say that your goal is to raise the rate of saving in the United States by 3 percentage points. What are the various ways you could accomplish this? Which of your solutions do you favor?Empirical
4. Suppose the real interest rate has increased from 2 to 4 percent.a. What will happen to the opportunity cost of consuming a set of goods today, as opposed to tomorrow? Explain how this will affect the fraction of income you choose to save.b. Now suppose that you save only to finance your
3. Suppose that 70 percent of a country’s population, as a consequence of liquidity constraints, behaves in accordance with the traditional model of consumption and thus consumes, every period, a given fraction of its disposable income. The other 30 percent of the population behaves in accordance
2. The graph below shows the lifetime earnings profile of a person who lives for four periods and earns incomes of $30, $60, and $90 in the first three periods of the life cycle. There are no earnings during retirement. Assume that the interest rate is 0.Income, consumption 1 2 3 4 Time$90$60$30a.
1. Suppose that permanent income is calculated as the average of income over the past five years; that is, YP 15( Y Y 1 Y 2 Y 3 Y 4 ) (P1)Suppose further that consumption is given by C .9 YP .a. If you have earned $20,000 per year for the past 10 years, what is your permanent
12.a. In the Barro-Ricardo view, does it make any difference whether the government pays for its expenditures by raising taxes or issuing debt?b. Why?c. What are the two main theoretical objections to the Barro-Ricardo view?Technical
11.a. Explain why the interest rate might affect saving.b. Has this relationship been confirmed empirically?
10. What assumption(s) regarding consumers’ knowledge and behavior in the life-cycle–permanent-income hypothesis do we need to change in order for it to explain the presence of precautionary, or buffer-stock, saving? Do these assumptions, in your opinion, bring the model closer to or further
9. What are the problems of excess sensitivity and excess smoothness? Does their existence disprove or invalidate the LC-PIH? Explain.
8. What is a random walk? How is Hall’s random-walk model of consumption related to the life-cycle and permanent-income hypotheses?
7. Rank the following marginal propensities to consume:a. Marginal propensity to consume out of permanent income.b. Marginal propensity to consume out of transitory income.c. Marginal propensity to consume out of permanent income when consumers are liquidity-constrained.d. Marginal propensity to
6. The United States, during the 1980s, found its rate of personal saving to be particularly low.It also, during that time, had a demographic blip—the baby-boomer generation, then in its late 20s to early 30s.a. Does the life-cycle hypothesis suggest a reason that these two facts might be
5. What are the similarities between the life-cycle and the permanent-income hypotheses? Do they differ in their approaches to explaining why the long-run MPC is greater than the shortrun MPC ?
4. Explain why successful gamblers (and thieves) might be expected to live very well even in years when they don’t do well at all.
3. In terms of the permanent-income hypothesis, would you consume more of your Christmas bonus if ( a ) you knew there would be a bonus every year, or ( b ) this was the only year the bonus would be given?
2.a. Suppose you earn just as much as your neighbor but are in much better health and expect to live longer than she does. Would you consume more or less than she does?Why? Derive your answer using the equation from the text, C ( WL NL ) YL .b. According to the life-cycle hypothesis, what
1. The text implies that the ratio of consumption to accumulated saving declines over time until retirement.a. Why? What assumption about consumption behavior leads to this result?b. What happens to this ratio after retirement?
2. The textbook states that under perfect capital mobility, interest rates in the home country cannot diverge from those abroad. In this exercise you will take a look at interest rates in the United States and the European Union.a. Go to http://research.stlouisfed.org/fred2. Click on “Interest
1. Go to http://research.stlouisfed.org/fred2. Click on “Exchange Rates” and then “By Country.”Find two countries that had a fixed exchange rate for a period sometime during the last 20 years. [Hint: Choose one of the developing countries (e.g., Malaysia, Thailand). ]
6. * This question is concerned with the repercussion effects of a domestic expansion once we recognize that, as a consequence, output abroad will expand. Suppose that at home there is an increase in autonomous spending, −A , that falls entirely on domestic goods. (Assume constant interest
5. What is the effect of a fiscal expansion on output and interest rates when exchange rates are fixed and capital is perfectly mobile? Show this rigorously, using the model developed in Section 12-5.
4. Illustrate, graphically, the effects of a fiscal expansion when capital is mobile and both prices and exchange rates are fixed. Over what horizon is the assumption of fixed prices a valid one? Explain.
3. Suppose you expect the pound to depreciate by 6 percent over the next year. Assume that the U.S. interest rate is 4 percent. What interest rate would be needed on pound securities, such as government bonds, for you to be willing to buy those securities with your dollars today and then sell them
2. In 1990–1992 Finland fell into serious difficulties. The collapse of exports to the Soviet Union and a dramatic fall in the prices of pulp and paper—important export items—led to both a recession and a current account deficit. What adjustment policies would you recommend for such a case?
1. Assume that capital is perfectly mobile, the price level is fixed, and the exchange rate is flexible.Now let the government increase purchases. Explain first why the equilibrium levels of output and the interest rate are unaffected. Then show whether the current account improves or worsens as a
10. Your country is in recession. You feel that a policy of exchange rate depreciation will stimulate aggregate demand and bring the country out of the recession.a. What can be done to trigger this depreciation?b. How might other countries react?c. When would this be a beggar-thy-neighbor
9. According to the Mundell-Fleming model, when exchange rates are fixed and capital is perfectly mobile, will fiscal or monetary policy be more successful? Explain.
8. When is a country in external balance? Internal balance? Should either or both of these be policy goals?
7. Why do economists care whether or not PPP holds?
6. Explain the purchasing power parity theory of the long-run behavior of the exchange rate.Indicate whether there are any circumstances under which you would not expect the PPP relationship to hold.
5. What is the difference between depreciation and devaluation?
4.a. If the dollar–pound exchange rate rises, has the dollar depreciated or appreciated?b. What has happened to the pound?
3. Explain how and why monetary policy retains its effectiveness when there is perfect mobility of capital.
2. * Consider a country that is in a position of full employment and balanced trade. The exchange rate is fixed, and capital is not mobile. Which of the following types of disturbance can be remedied with standard aggregate demand tools of stabilization? Indicate in each case the impact on external

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Macroeconomics 11th Edition Rudiger Dornbusch, Stanley Fisher, Richard Startz - Solutions

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