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Questions and Answers of
Macroeconomics
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 lesser of the two).
Go to the St. Louis Federal Reserve FRED database, and find data on house prices (SPCS20RSA), stock prices (SP500), a measure of the net wealth of households (TNWBSHNO), and personal consumption
Go to the St. Louis Federal Reserve FRED database, and find data on corporate net worth of nonfinancial businesses (TNWMVBSNNCB), private domestic investment (GPDIC1), and a measure of financial
Go to the St. Louis Federal Reserve FRED database, and find data on the three month U.S. Treasury note (TB3MS), the three-month AA nonfinancial commercial paper rate (CPN3M), the federal funds rate
Identify the four main categories of government spending and give an example of each. What are the government’s four main revenue sources?
What is a budget deficit, and what are the two main ways in which the government can finance deficit spending? Which of these methods of financing deficits does the U.S.government most commonly use?
What factors have influenced the debt-to-GDP ratio in the United States since 1940?
What arguments should be considered in assessing the burden that government debt imposes on future generations?
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?
How does a supply-side analysis of the effects of a tax cut differ from one that focuses solely on aggregate demand?
Is balancing the budget a contractionary macroeconomic policy?
Why are fiscal multipliers higher when the policy rate has hit the floor of the zero lower bound?
What determines whether budget deficits will result in inflation in the long run?
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?
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
Assume that Social Security tax rates remain constant but the number of employed people in the United States declines over time.a) Explain the effect of such a scenario on the size of contributions
The definition of the government deficit is a matter of debate. What would be the effect on the measurement of the government deficit if one considered Social Security taxes a “forced loan to the
In recent years, the United States has experienced a sharp increase in obesity rates (in particular amongst teenagers), which is considered to increase the probability of chronic diseases like
As announced by the Obama administration, part of the 2009 fiscal stimulus package was directed to making broadband Internet access available to most Americans.a) Should this plan be considered
Concerns about the ability of the U.S. government to finance its own budget deficit might lead to higher interest rates on U.S Treasury securities.a) Explain the effect of higher interest rates on
Assume that the expenditure and tax multipliers can be estimated at 0.75 and 0.5, respectively.a) Would you recommend expansionary fiscal policy based on tax cuts or increased government
A government committed to long-run fiscal discipline (i.e., low or zero budget deficits) usually conducts contractionary fiscal policy at some point to reduce the government deficit. If that action
Use an IS graph, an MP graph, and an AD/AS graph to show the effects of a decrease in taxes on short-run output in the two cases described in parts (a) and (b). Assume that the tax decrease is the
What would happen to revenue from seignorage if the inflation rate was very high? check Equation 8 and assume a quickly rising price level. M/P = (M/P) (8)
Consider the effect of a tax cut (if government spending remains the same) in a country with an underdeveloped financial system.a) Assuming individuals are forward looking (i.e., the Ricardian
Go to the St. Louis Federal Reserve FRED database, and find data on the total government debt as a percentage of GDP (GFDEGDQ188S) and gross domestic product (GDP).a) Report the most current
Go to the St. Louis Federal Reserve FRED database, and find data on the total public debt by the federal government (GFDEBTN) and the amount of debt held by foreign and international investors
Go to the St. Louis Federal Reserve FRED database, and find data on the budget deficit (FYFSD), the amount of federal debt held by the public (FYGFDPUN), and the amount of federal debt held by the
What is the foreign exchange market? Describe the two types of transactions that take place in this market.
Differentiate the nominal and real exchange rates between dollars and euros. Do the two exchange rates move together? Why is appreciation or depreciation of real exchange rates important?
How is the theory of purchasing power parity related to the law of one price? Why doesn’t PPP hold in the short run?
Why does the foreign exchange market move toward equilibrium when the foreign exchange rate for the dollar is either above or below its equilibrium value?
Identify three factors that might cause the exchange rate for a currency to rise.
What are the short-run effects on aggregate output and the inflation rate when the domestic currency appreciates or depreciates?
Why do central banks intervene in foreign exchange markets? How do these interventions affect their international reserves and exchange rates?
How do fixed, floating, and managed (dirty)float exchange rate regimes differ?
What happens in a fixed exchange rate regime if a currency is overvalued? What problem can this create?
What are the advantages and disadvantages of exchange-rate pegging?
Suppose a bottle of wine sells for $16 in California and for €10 in France. Assuming a nominal exchange rate of 0.75 euro per dollar,a) calculate the real exchange rate between U.S. wine and French
A Starbucks coffee sells for 10 yuan in Beijing, China, and for $2 in Chicago.a) Calculate the nominal exchange rate if the law of one price holds.b) Assume that the nominal exchange rate is
In each of the following examples, the law of one price does not hold (i.e., at current nominal exchange rates, the prices of these goods or services are not the same). For each case, explain what
On June 19, 2013, following the FOMC’s regular policy meeting, the Chair of the FOMC made remarks during a press conference that were widely interpreted in financial markets to mean that the Fed
The following table shows the nominal exchange rate between the U.S. dollar and the euro (U.S. dollars per euro) at different points in time.a) Plot the nominal exchange rate, and determine whether
Suppose the Federal Reserve cannot convince the public of its commitment to fighting inflation in the United States in the near future.a) What would be the effect on the expected appreciation of the
Brazil has announced the discovery of huge oil reserves that could potentially transform the country into a big exporter of oil.a) What would be the effect of the increase in revenues from oil
The following T-account (in billions of dollars)depicts an intervention by the Federal Reserve in the foreign exchange market:a) Did the Federal Reserve buy or sell U.S. dollars?b) What is the effect
Explain why a central bank might want to intervene in the foreign exchange market to prevent an excessive appreciation of its currency, even if it previously stated that it would allow its currency
Assume that a country has pegged the value of its currency to another country’s currency and that the anchor country increases its interest rate. Describe the effects on the following:a) The export
Go to the St. Louis Federal Reserve FRED database, and find data on daily dollar exchange rates for the euro (DEXUSEU), British pound (DEXUSUK), Japanese yen (DEXJPUS), Chinese yuan (DEXCHUS), and
Go to the St. Louis Federal Reserve FRED database and find data on the exchange rate of U.S. dollars per British pound (DEXUSUK). A Mini Cooper can be purchased in London, England, for £17,865 or in
Go to the St. Louis Federal Reserve FRED database, and find data on the daily dollar exchange rates for the euro (DEXUSEU), British pound (DEXUSUK), and Japanese yen (DEXJPUS). Also, find data on the
Go to the St. Louis Federal Reserve FRED database, and find data on the monthly U.S. dollar exchange rates to the Chinese yuan, Canadian dollar, and South Korean won. Download the data onto a
Why is a theory of consumption also a theory of saving?
What is the logic behind the intertemporal budget constraint? On what assumptions is it based, and how is its slope interpreted?
What do indifference curves show about current and future consumption? Why do they slope downward? Why are they convex?
Explain how the intertemporal budget constraint and indifference curves are used to derive a consumer’s optimal choice of current and future consumption.
What can shift the intertemporal budget line, IBL? What happens to current and future consumption when IBL shifts occur?
How do changes in the real interest rate affect the IBL and current and future consumption?
How do binding borrowing constraints affect the IBL and current and future consumption?
On what assumptions did Keynes base his theory of consumption? How does his theory relate to intertemporal choice?
What is the permanent income hypothesis? How does its consumption function relate to intertemporal choice?
Describe the life-cycle hypothesis and how it relates to intertemporal choice.
What modifications to the intertemporal choice theory have been suggested by the random walk hypothesis and behavioral economics?
Suppose Prakash has an income today of $30,000, an expected income in period 2 of $35,000, and initial wealth of $5,000. Prakash faces an interest rate of 5%.a) Graph Prakash’s intertemporal budget
Assume that Maria does not have a preference for smooth consumption. In particular, the average of two consumption points on the same indifference curve yields the same utility to Maria as either
Describe the effect of an increase in next period’s income on the intertemporal budget constraint. If next year’s income increases by $3,000 and the interest rate is 5%, by how much does the
The following figure represents the optimization problem for a homeowner whose home is currently valued at $250,000.a) Identify the optimum consumption point (i.e., what are the values of C1 and C2
Describe the effects of a decrease in the interest rate on present and next period’s consumption if the individual is a net lender (i.e., has savings) after period 1 and the substitution effect is
Suppose Nicole’s yearly income is $5,000 when she is fifteen, $35,000 when she is twenty-five, and $70,000 when she is fifty (these are all present value measures of future income). Assume that
What does the Keynesian consumption function imply about the average propensity to consume of a rich versus a poor country? Which country should have a higher average propensity to consume?How can
In May 2010, the size of Greece’s budget deficit increased its probability of default and triggered a crisis across the Eurozone. To decrease the budget deficit, the Greek government proposed many
For each of the following situations, explain how current consumption will change according to the random walk hypothesis:a) The government increases taxes to close the budget deficit, but the size
Previous policies to increase saving in the United States have included fiscal policy measures to exempt a part of individuals’ savings from income taxes (e.g., the creation of IRAs).According to
Go to the St. Louis Federal Reserve FRED database, and find data on real personal consumption expenditures (PCECCA) and a measure of real interest rates, the 10-year treasury inflation-indexed
Go to the St. Louis Federal Reserve FRED database, and find data on disposable personal income (DPI), personal saving (PSAVE), and personal consumption expenditures (PCEC). Download the data onto a
Go to the St. Louis Federal Reserve FRED database, and find data on the civilian population (CNP16OV) and the civilian population 55 years old and over (LNU00024230). Convert the two population
Go to the St. Louis Federal Reserve FRED database, and find data on the University of Michigan’s consumer sentiment index (UMCSENT) and real personal consumption expenditures (PCECC96). Convert the
Identify and give examples of the three components of investment spending.
What is the user cost of capital? What variables determine this cost, and how does a change in each variable affect it?
Explain how the user cost of capital and the expected marginal product of capital together determine the desired level of capital.
According to the neoclassical theory of investment, how do firms determine their optimal amount of investment spending once they have identified their desired level of capital?
Explain how the desired levels of capital and investment are affected by changes in the expected marginal product of capital, the user cost of capital, and taxes.
Why do firms hold inventories, and why is their inventory investment a matter of interest to macroeconomists?
What is Tobin’s q? How does it provide a theory of investment spending?
How are Tobin’s q theory and the neoclassical theory of investment related?
What kinds of policies has the U.S. government pursued to encourage home ownership, and how do they achieve this goal?
Assume that Luke is considering investing in new equipment and computers for his construction company. The real interest rate is 5%, construction equipment is valued at $600,000, and computers are
Using the expression for the expected marginal product of capital, MPKe = 3.6/Kt+1, plot the MPKe curve and determine the desired level of capital for the next period (measured in trillions)if the
Explain the consequences of each of the following events on the desired level of capital stock for the next period according to the neoclassical theory of investment:a) An autonomous easing of
Discuss the effect of the investment tax credit implemented in the United States after the global financial crisis. What does empirical evidence suggest about the link between taxes and investment?
One common feature of developing countries is their relatively less-developed financial systems. What are the implications of a less efficient financial system for the level of investment in
Oil leaks from offshore drilling platforms in the Gulf of Mexico have resulted in stricter regulations on this type of oil extraction.a) Discuss the effects of such regulations on the user cost of
The following graph shows the quarterly change in private inventories in the United States from 2007 to 2010. (Figures are billions of 2005 dollars.) Explain the changes in private inventories during
From 2009 to 2013, stock prices doubled in the United States. What was the likely effect of this stock market rise on business investment in the United States? Explain using Tobin’s q theory.
A relatively recent trend in most developed countries, including the United States, is the creation of single-person households. Discuss the short- and long-run consequences of this trend on
The Federal Reserve has promised that at some future date, it will raise interest rates as part of its “exit strategy” from the expansionary monetary policy it pursued in the aftermath of the
Go to the St. Louis Federal Reserve FRED database, and find data on real private domestic investment (GPDIC96), real residential investment (PRFIC96), and real non-residential (business) fixed
Go to the St. Louis Federal Reserve FRED database, and find data on net domestic investment (A557RC1Q027SBEA) and gross domestic investment (W170RC1Q027SBEA).a) For each series, report the values for
Go to the St. Louis Federal Reserve FRED database, and find data on the 30-year mortgage rate (MORTG), private residential fixed investment (PRFI), and the net percentage of bankers tightening credit
What is the employment ratio? What notable trends in this ratio have occurred over the past fifty years?
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