ECON204 final

* Which of the following were contributing factors to the Great Depression:

- The stock market crash of 1929 - The Bank Crisis - Deflation

Long-run shifts in wage-setting curve: Technical change can indirectly shift wage-setting curve up

-Bargains by unions -Policies -Greater effort -Increase in reservation wage (changes in unemployment benefit)

Modeling technological progress (production function)

-Capital intensity: capital goods per workers -Labor productivity: output per worker -Diminishing returns -Technological progress rotates production function UPWARDS, off-setting diminishing returns

Causes of inflation: wage-price spiral

-Competition falls and firms become more powerful relative to consumers -Firms lower their price and the real wage lowers, prices and wages now risen and inflation happens -shift down in price-setting curve (supply shock)

Golden age effects

-Decrease unemployment -Increase growth -Decrease inequality

Great Depression effects

-Increase unemployment -Decrease growth -Decrease productivity

Financial crisis effects

-Increase unemployment -Decrease inflation -Increase inequality

creative destruction features

-Innovation causes creative destruction as they diffuse through economy -Firms that CAN'T compete, exit the market -An emphasis on role of enteprenures as the agent introducing new technologies and products

Financial Crisis: role of the bank

-Insolvency -Financial assets hard to value -Liquidity problems -Fire sales

Whats wrong with deflation

-MORE dramatic consequences than high inflation -When prices fall, households will POSTPONE CONSUMPTION because they expect goods will be cheaper in the future. -It increases the real DEBT BURDEN, which may lead households to cut consumption -A DEFLATIONARY SPIRAL: decrease in prices -> lower -> demand -> further decrease in prices

Monetary policy (how to deal with demand/supply shock)

-Market interest rates to desired target level - Exchange rates thought net exports

Great Depression policies and what got us out:

-New deal (increase AD) -Left gold standard (increase control over money supply -Nominal interest rates close to zero -WWII

Long-run vs short/medium-run adjustment to technological improvements

-New technologies can increase real wages and employment in long run, but it takes time and leads to job destruction in short run -Adjustment gap -Diffusion gap

Inflation and the role of expectations

-People are forward-looking -People treat prices as messages

Stagflation

-Persistent high inflation combined with high unemployment

Golden age, what ended it

-Price setting curve shifted down -Oil price shocks

Problems with the great moderation

-Rising debt -Increasing housing prices -Rising inequality

The bargaining gap

-The difference between real wage that firms wish to offer in order to provide workers with incentives to work and the real wage that provides firms the ability to maximize their profit -Inflation = bargaining gap %

Inflation-stabilizing unemployment rate

-The unemployment rate at which inflation is constant

Causes of labor market mismatch

-Unemployed workers might not have skills for available jobs -Location mismatch -Job-seekers and employees might not know each other

Labor market model in the long-run vs short/medium-run

-Worker incentive demand on wage setting curve -Investment incentives depend on price-setting curve -Higher mark-ups means that firms enter

Causes of inflation: workers become more powerful relative to firms due to a fall in unemployment rate, short to medium run

-Workers demand a higher wage, this increases the cost of production so firms increase prices -A decrease in unemployment rate (demand shock)

Causes of inflation: workers become more powerful ratline to firms, medium to long run

-Workers demand a higher wage, this increases the cost of production so firms increase prices -Shift left (up) in wage-setting curve (supply shock)

What is wrong with inflation?

-creates VOLATILE economy -it's harder for producers to distinguish between changes in RELATIVE PRICES and inflation -MENU COSTS as firms have to update their price labels -BORROWERS and LENDERS benefit differently

Hyperinflation

-inflation where rates are at least 50% or more -driven by government printing money and money supply increases

Central bank indolence is important because

-more independence the bank has, the less the average inflation -political incentive is not there to raise inflation rates

3 causes of inflation

-wage-price spiral - workers become more powerful ratline to firms, medium to long run -workers become more powerful relative to firms due to a fall in unemployment rate, short to medium run

* If inflation is 4% this year and the bargaining gap is 1%, what does the model predict inflation will be next year?

5%

supply shock

A NEGATIVE ______ will INCREASE inflation and unemployment at the same time

demand shock

A NEGATIVE ______ will INCREASE unemployment and REDUCE inflation

zero inflation

A constant price level from year to year (stationary car)

All of the following would cause inflation EXCEPT:

A decrease in aggregate demand

In an imaginary economy, GDP falls from $100 billion to $95 billion while output per worker rises from $5000 to $5020. In this economy there has been:

A fall in production and an increase in productivity. (There has been a fall in production but an increase in productivity per worker. In these circumstances, it is a reasonable inference that unemployment must have risen as well.)

All of the following could cause deflation EXCEPT:

A leftward (up) shift in the wage-setting curve (This would lead to a positive bargaining gap and inflation.)

An overseas bank announces that it is introducing a new type of savings account paying a 3 percent fixed rate of interest for deposits of one year duration. This 3 percent is:

A nominal rate of interest

The Phillips curve models which relationship?

As unemployment decreases, inflation increases.

* Assume that you've had to borrow from the Department of Education to pay for CSU, specifically you borrow $20,000 at a fixed 7% interest rate. Overtime inflation you will make you (relatively):

Better off

Great Depression causes:

Causes -Pessimism about the future -Banking systems failure -Deflation

Golden age causes:

Causes: -Changes in economic policy (making regulation) -Size of government increased -Bretton woods system (more flexibility than gold standard) -Post war accord -Technological advantage

It is often said that independent central banks are more likely to run a successful monetary policy than governments because their commitment to low inflation is more 'credible' than government promises. One reason for this is that:

Central banks are less subject to political pressures (e.g. for lower unemployment) than governments.

Phillips curve: why it shifts

Changes/ shocks in aggregate supply, expected inflation

What is a monetary policy a government may use to stabilize the economy in response to an unexpected decline in aggregate demand?

Decrease nominal interest rates (This is a expansionary monetary policy that would increase aggregate demand and stabilize the economy.)

Imagine that the rate of inflation has been 10 percent per year for a number of years. The central bank then introduces a 'tight' monetary policy and the rate of inflation comes down to 5 per cent per year. This reduction is an example of:

Disinflation: refers to a situation where inflation (the rate of change of increasing prices) is being reduced.

* Which factor amplified and prolonged the Great Depression?

Fiscal austerity

The beverage curve shifted CLOSER to origin because of reforms that helped unemployed workers find jobs in ____

Germany

Which of the following might help to minimize the costs of adapting to new technology?

Government re-training schemes

The crisis that marked the end of the golden age is sometimes described as a supply-side phenomenon in contrast to the crisis of the 1930s, which was caused by inadequate demand. Which of the following did NOT contribute to problems on the supply side in the 1970s?

High levels of employment.

All of the following were considered to be contributing factors to the Great Depression except:

Housing price bubble

Causes of Financial Crisis

Housing prices began to fall -> prices began to fall further ->investment and consumption fell -> spillover effects to the financial sector -> increased unemployment.

Which of the following statements is correct regarding the model of the labor market?

In the short- and medium-run models the amount of capital is fixed, while in the long-run model the amount of capital can vary.

What is a fiscal policy a government may use to stabilize the economy in response to an unexpected decline in aggregate demand?

Increase government expenditures (This is a expansionary fiscal policy that would increase aggregate demand and stabilize the economy.)

* If competition falls and firms become more powerful relative to consumers, firms will...

Increase their prices

Which of the following was NOT a policy reform used in the US to deal with the stagflation of the 1970s?

Increasing government expenditures

The Beveridge curve will shift downward (toward the origin) if:

Information about job vacancies improves. (The fact that workers cannot find the matching vacancies and employers cannot find the relevant workers is another reason why vacancies exist alongside unemployment. Helping the two sides to find each other result in more of the vacancies being filled at every level of unemployment, and so the Beveridge curve shifts down.)

Deflation refers to a situation where prices are generally falling. Why is deflation generally undesirable?

It might lead to a reduction in aggregate demand as firms and households wait for prices to fall further.

Great moderation

Low and stable inflation

Why has the US been moving into the services sector?

Manufacturing productivity increases, shift feasible frontier

Firm entry/exit and profits

More firms -> more competition -> lower profit -> less firms

In the short run, successive additions to capital produce smaller and smaller increases in output. In the long run, however, GDP continues to rise. This is because:

New capital equipment incorporates the latest technological developments.

Why was Norway successful where Spain failed?

Norway implemented inclusive trade unions and employers association where Spain was not inclusive and did not have policies that doesn't protect workers

Imagine that you are responsible for policymaking in an economy that is experiencing a deep recession. You and your colleagues announce a number of measures (like those in Roosevelt's 'New Deal') that you tell everyone will boost demand and output. Why does it matter whether the public believes your announcement?

People will feel more confident about the future and increase their spending, which will reinforce the actions of government.

What are the problems that arose from the great moderation

Rising inequality Rising debt Rising house prices

A fall in the world price of commodities (e.g. oil) will:

Shift the profit curve up and the Phillips curve down. (If commodity prices fall, firms will make larger profits than they need and so competition will lower prices. The price level falls. This raises real wages so the price-setting curve moves up. This creates a negative bargaining gap. This gap will be eliminated if the level of unemployment falls, so that zero inflation is now associated with a higher level of employment The Phillips curve has shifted down.)

The beverage curve

Shows inverse relationship between unemployment rate and job vacancy rate

_____ was caused by the shifting up of the Phillips curve, propelled by higher inflation expectations.

Stagflation

The relationship between the unemployment rate and the job vacancy rate (each expressed as a fraction of the labour force) is known as:

The Beveridge curve

The widespread introduction of new technology into an economy takes time. The length of time between first appearance and general acceptance is known as:

The diffusion gap

In a severe recession, with falling prices, the economy may need a negative real interest rate in order to give sufficient stimulus to aggregate demand. What particular problem for conventional monetary policy do negative real interest rates pose?

The policy rate needs to be more negative than the rate of deflation but nominal rates cannot go below zero. (This is the real problem. If the rate of inflation falls to zero and the economy requires a stimulus, it may need a rate of interest below zero. But it is very difficult to see how a negative rate of interest could be imposed. The moment that assets begin to pay negative rates (meaning that their holders are paying borrowers), their holders will sell and hold notes and coins instead.)

* If workers become more powerful due to an economic boom and lower unemployment...

The price- & wage-setting curves won't change

* If competition falls and firms become more powerful relative to consumers...

The price-setting curve will shift down

* If workers become more powerful due to stronger trade unions...

The wage-setting curve will shift up

Which of the following statements is correct regarding monetary policy?

The zero lower bound refers to the central bank's inability to set the nominal interest rate to below zero. (The central bank can set the real interest rate to below zero by setting the nominal interest rate below the inflation rate (recall the Fisher equation). The problem is that they are unable to set the nominal interest rate below zero, so the real interest rate cannot go below minus the inflation rate.)

* Based on our inflation model with expectations

There is one unemployment rate at which inflation is stable

Which of the following is a distinctive characteristic of 'inclusive unions'?

They represent many firms and sectors

The beverage curve shifted AWAY from origin due to skill- based mismatch and limited worker mobility in _____

US

Which of the following best describes the short-run relationship between inflation and unemployment, ceteris paribus?

Unemployment rises; inflation falls. (An inverse relationship or 'trade-off' means that inflation and unemployment move in opposite directions.)

* Suppose that you lend me $100 and I promise to pay it back next year (with no interest). Inflation over the year will make you (relatively):

Worse off

disinflation

a decrease in the RATE of inflation (car slowing down, 4, 2, 1)

deflation

a decrease in the general price level ( car driving backwards)

Subprime mortgages

a mortgage issues to a high-risk borrower

The great depression was caused by issue of

aggregate demand

Inflation

an increase in the general price level (car driving at a constant speed)

Who is at fault for financial crisis

banks

Borrowers with nominal debt will benefit:

because the debt stays the same in nominal terms, and so because smaller in real terms

Lenders with nominal assets will lose:

because when the sum is repaid, it will be worth less in terms of the goods it can buy.

* In response to the increase in prices (and holding employment fixed), workers will...

demand a higher nominal wage for same effort

great depression: supply or demand side shock?

demand side

Rising inflation

in increase in the RATE of inflation (car accelerating)

Adjustment gap

lag between some outside change in labor market and movement to new equilibrium

The Philips curve relationship shows

low unemployment may result in inflation -Shows that inflation and unemployment have a table and inverse relationship

Higher inflation means

lower real value of income and reduces the real value of debt

why is central bank independence important

politicians may be too willing to trade lower unemployment for future inflation

Job creation is _____ and job destruction is _____

procyclical, countercyclical

Fisher equation

real interest rate= nominal interest rate - inflation rate

golden age: supply or demand side shock?

supply side

Golden age ended because of

supply side crisis

Diffusion gap

time it takes for economy to adopt...

An economy has an independent central bank with an inflation target of 2% considers an aggregate demand shock that increases unemployment. what is correct?

with out monetary or fiscal policy to counter the negative bargaining gap, the Philips curve would shift down