Final Review Macro - 2nd 50 Qs

What impact does an open economy (trade) have on the effectiveness of monetary policy? On fiscal policy?

Strengthens monetary policies impact on aggregate demnand - i.e., makes it more effective due to the effect of interest rate changes on exports and imports and this aggregate demand Ms↑→i↓ →I ↑→D ↑ And Ms↑→i↓ →$↓ →X ↑ & M↓ →D ↑ more Reduces the impact of fiscal policy on aggregate demand due to a form of crowding out G↑→i↑→ $↑→D ↓

What is deflation and what harm does it cause?

Sustained decrease in general level of prices Generally caused by recession/depression-weak D Consequences Real interest rates increase r real=r nominal - - inflation Monetary policy may lost traction - real int rates increase despite nominal declines - great depression debt burden increases - depression Deflationary spiral - D falls, reducing y and P, postpone C&I, reducing D & p further - Dump assets to pay debt, further reducing p etc.

Define the natural rate of unemployment (NAIRU). Why does it matter?

The 'full-employment' unemployment rate at which there is structural and frictional but not cyclical unemployment o The long-term unemployment rate at which inflation does not increase (i.e., there is no acceleration in prices - hence the non-accelerating inflation, rate of unemployment o The rate at which the LR Phillips curve is vertical Vertical (at NAIRU) - cannot lower unemployment rate below natural rate in the long run, and if attempt to do so, more inflation only The Nairu is supposed to capture the sweet spot - the lowest level to which the unemployment rate can safely fall before inflation starts to accelerate.

What's the core cpi? The chain-weighted cpi?

The core CPI index excludes goods with high price volatility, such as food and energy. Chain-weighted CPI is an alternative measurement for the Consumer Price Index (CPI) that considers product substitutions made by consumers and other changes in their spending habits.

What are government entitlement programs and what LR issues do they raise?

The kind of government program that provides individuals with personal financial benefits (or sometimes special government-provided goods or services) to which an indefinite (but usually rather large) number of potential beneficiaries have a legal right (enforceable in court, if necessary) whenever they meet eligibility conditions that are specified by the standing law that authorizes the program. Entitlement programs are not self-funding and are a main driver of deficits, growing at alarming rates

What's the long-run Phillip's curve? What's the implication of the slope of the long-run Phillip's curve.

The long-run Phillips curve is a vertical line at the natural rate of unemployment (inflation does not affect employment) The Long Run Phillips Curve was devised after in the 1970s, the unemployment rate and inflation rate were both rising (this came to be known as stagnation

What were some of the major consequences of the crisis- economic, political, social, financial?

losses of trillions of dollars Collapse of major banks and financial institutions Undermining belief in free and efficient markets Heavy involvement of gov'ts in economies Leading to World-wide RECESSION TARP 2008 - Bush, Paulson ARRA-American Recovery and Reinvestment Act Major changes in regulation, personal finance, politics, education, macroeconomics, financial economics, monetary policy

What are some key points of each of the following? a. Classical Macro b. Keynesian Economics c. Supply-side Economics d. Monetarism e. Rational Expectations

a. Classical Macro - focus on LR aggregate supply, economy self-adjusting in longrun (full employment-Say's Law), money supply affects prices and inflation only, interest rates determined by saving and investment (supply and demand for loanable funds) b. Keynesian Economics - focus on SR and aggregate demand; economy not selfadjusting; periods of recession, unemployment etc; increase aggregate demand to deal with this, thru fiscal policy primarily; money supply affects agg D and everything else in the SR but may not be effective in recession/depression if in a liquidity trap c. Supply-side Economics-in **SR**, tax cuts and other incentive programs can shift aggregate **Supply** and this increase output, income, etc without inflation and without government spending d. Monetarism -Milton Friedman, SR - Money has the largest impact on aggregate demand and thus output, recession, etc. in LR, basically classical e. Rational Expectations hypothesis that people make optimal (but not always correct) economic forecasts and thus leads to an essentially classical outcome, with monetary and fiscal policy having little or no impact

What role did the following play in the crisis? (GR) a. leverage, b. securitization and derivatives-mbs, cdos, cds, c. funding mismatch, d. shadow banking sector, e. deregulation, f. too big to fail/moral hazard, g. wealth effect h. animal spirits, deleveraging, fire sales i. systemic risk

a. leverage - extensive (""Crises are most severe when accompanied by a lending boom and high leverage of market players") b. securitization and derivatives-mbs, cdos, cds - securitization was the practice of buying mortgages (IOUs) from banks, bundling them together, and selling to Wall Street a bond with the interest and principal repayments from the mortgages passing through to the bond holders - these are MBS. The creaters (Goldman, etc) earned high fees from this. c. funding mismatch - Lehman and others borrowed weekly, invested longer term d. shadow banking sector - when the short term lenders to the shadow banks got nervous, they refused to re-fund (i.e., loan the more money) e. deregulation - discrete regulatory changes from 1999 to 2004 enabled commercial and investment banks to take excessive risks. f. too big to fail/moral hazard, - excessive risk/complacency Before the financial crisis, financial institutions' expected that regulating authorities would not allow them to fail due to the systemic risk that could spread to the rest of the economy g. wealth effect - stock market and housing h. animal spirits, deleveraging, fire sales- debt deflation as uncertainty rose in the financial system, many institutions needed cash to meet short-term obligations and were forced to sell their MBS etc at falling prices - a fire sale i. systemic risk- Dodd Frank: Created a new financial stability oversight council (fed, treasury, sec, fdic, etc) to evaluate systemic risk "Several developments played a role, including the proliferation of complex mortgage-backed securities and derivatives with highly opaque structures, high leverage, and inadequate risk management. These, in turn, created systemic risk - that is, the risk that a triggering event, such as the failure of a large financial firm, will seriously impair financial markets and harm the broader economy"

How does long-run U.S. growth generally compare with Europe? Asia? Africa?

about same-- lower about same-- high in some low growth

Which is considered more dangerous, inflation or deflation?

deflation

How does a strong currency affect the domestic economy?

stronger currency leads to fewer exports, which depresses AD

According to marginal productivity theory, what is a key determinant of the real wage (in theory)?

is a theory in neoclassical economics stating that wages are paid at a level equal to the marginal revenue product of labor

Why was the yuan undervalued in China in the past?

to promote exports (???)

Why are some benefits of international trade? Some of its harms?

trade leads to increased competition and transmission of ideas and technology, allows consumption beyond PPF. Some may lose jobs and have to retrain

What's a Speculative Asset Bubble?

Rapid increase in an assets price not justified by economic fundamentals. Eventually bursts

What can cause inflation in the short-run?

Demand-pull, cost push Wage- price Spirals (The wage-price spiral is a macroeconomic theory used to explain the cause-and-effect relationship between rising wages and rising prices,) Wage Price Guidelines

What issues does China's pegged or managed exchange rate system present?

- lose control of domestic money supply with fixed rates and capital mobility Possible speculative attacks - A speculative attack in the foreign exchange market refers to the massive and sudden selling of a nation's currency and can be carried out by both domestic and foreign investors. inflation concerns

What is a government budget deficit? The national debt?

A budget deficit occurs when expenses exceed revenue, and it is an indicator of financial health. The federal or national debt is simply the net accumulation of the federal government's annual budget deficits: It is the total amount of money that the U.S. federal government owes to its creditors.

What is/are: a SIFI (systemically important financial institution)? The Financial Stability Oversight Council? The Consumer Financial Protection Bureau?

A systemically important financial institution is a firm that U.S. federal regulators determine would pose a serious risk to the economy in the event of its collapse; the label reflects the concept of "too big to fail" and imposes extra regulatory burdens. The Financial Stability Oversight Council (FSOC) was formed as a part of the passage of the Dodd-Frank Act to monitor risks to the US financial sector from the issues of large banks or financial holding companies that could derail the economy. The Consumer Financial Protection Bureau (CFPB) is supposed to prevent predatory mortgage lending (reflecting the widespread sentiment that the subprime mortgage market was the underlying cause of the 2008 catastrophe) and make it easier for consumers to understand the terms of a mortgage before finalizing the paperwork. (also came from D-F)

Why do we have a current account deficit, and what does it imply?

Americans spend more on imports than U.S. businesses export. Financial Account Surplus Weakens aggregate demand, slows economy, selling assets or going into debt twin deficit problem we're in debt

What is the basic idea of comparative advantage?

Countries specializing in goods and services they have a relative advantage in producing (produce at a lower opportunity cost) and trading for the rest, wind up with more of everything than if they tried to produce everything

What causes the short-run Phillip's curve to shift up?

Decreases in aggregate supply shift the short run Phillips Curve to the right, and they include: An increase in expected inflation Shifts of the SRPCSRPC, such as a movement from point 2 to point 3, indicate a change in short-run aggregate supply When SRAS shifts, the SRPC shifts in the opposite direction, as summarized in the table below: The shift in SRPC represents a change in expectations about inflation. For example, suppose an economy is in long-run equilibrium with an unemployment rate of 4% and an inflation rate of 2%. If there is a shock that increases the rate of inflation, and that increase is persistant, then people will just expect that inflation will never be 2% again.

What harm does unanticipated inflation cause?

Distortion of signaling function of prices, distortions in tax system (bracket creep), redistribution from lenders to borrowers (real rate falls with inflation) and thus reduced desire to lend (paying back with "cheaper" dollars)

What monetary policy actions were taken to deal with the crisis (conventional and unconventional)? GR

Early on, expansionary conventional policy - reduction of fed funds rate to 0, reduction of discount rate, increased purchase of government securities (open market operations). Later, several rounds of quantitative easing - purchases of longer term government and mortgage backed securities to lower long-term interest rates, expanded lender of last resort role to banks and many non-bank financial institutions and entities including Bear Stearns, AIG, etc. Also considerable 'forward guidance' - explanations to market participants about their future actions, so as to shape expectations.

What is purchasing power parity theory?

Exchange rates adjust in LR to equalize prices

What are the advantages of floating exchange rates? Fixed exchange rates?

Flexible Rates: Automatically Balance S&D for currencies Shock absorber - currency depreciation to adjust to weak economy fixed:eases int'l business/trade Certainty

What's the relation between Fed credibility and inflation? Between inflation expectations and inflation? Between unemployment and inflation?

Gaining credibility would require a period of prioritizing low inflation over low unemployment. Only then would long-run inflation expectations be set in a way that did not fluctuate with short-term interest rate policy. Modern economic theory says that inflation expectations are an important determinant of actual inflation phillips curve

What is the 'twin deficit problem'? The 'tri-lemma'?

Government Budget Deficit MAY leads to Current Account deficit M-X=(G-T)+(I-S) tri-lemma says that a country gets to choose only two of the following three desirable things: 1. Fixed exchange rates (reduces uncertainty in international trade) 2. Discretionary monetary policy (control the money supply to control inflation) and 3. Capital mobility (allow funds to freely flow in and out of a country - encourages investment etc). Thus the U.S. has 2 and 3 but has FLEXIBLE exchange rates. China has some variation of 1 and 3 and thus loses some control of monetary policy and runs some risk of inflation (in fact they also limit capital mobility)

What is hyperinflation? What causes it? What are the consequences? What's the cure?

Hyperinflation - extreme inflation (too rapid) When associated with depressions, hyperinflation often occurs while there is a significant increase in the money supply not supported by gross domestic product (GDP) growth, resulting in an imbalance in the supply and demand for the money. Left unchecked, this causes prices to increase, as the currency loses its value. Eliminates confidence in money Barter or new currency To stabilize the economy, the Brazilian government created a virtual currency called a unit of real value (URV). URV's intangibility and transparency made it much more trustworthy and dependable than the previously issued paper money. Therefore, if Venezuela can adjust its large imbalances and establish some fiscal disciplines to restore people's trust in the financial system, its hyperinflation could be tamed down eventually.

What are the determinants of exchange rates in the short-run? In the long-run?

In the short run, floating (flexible) exchange rates determined by the supply and demand for a currency on the fx market . The demand for say the yen depends on the demand for Japanese goods and services and for Japanese real and financial assets. We will focus on the demand only. Thus, lower interest rates in Japan as compared to the U.S. will lower the demand for yen by americans and cause the yen to depreciate (the $ to appreciate). An increase in demand for Japanese cars will cause the demand for yen to appreciate In the long-run, exchange rates determined by PURCHASING POWER PARITY meaning that they adjust to equalize the cost of tradeable commodities. This means that if the U.S. say has higher inflation in the long-run than Japan, the $ should depreciate against the yen (since the higher inflation in the U.S. would mean that steel prices were increasing in dollars and thus a yen would have to buy more dollars to equalize the price with that in yen.

What is Dodd-Frank? The Volcker Rule?

Increased capital requirements for banks Created a new financial stability oversight council (fed, treasury, sec, fdic, etc) to evaluate systemic risk Fed regulation of SIFIs (non-bank as well as bank) increased regulation and transparency of derivatives, Volcker rule - limit bank proprietary trading consumer financial protection agency - rules, etc. FDIC "resolution regime" shut down non-bank SIFIs Some consolidation of regulatory agencies Some roll-back underway

What is the largest source of federal government revenue? Largest spending item?

Individual income taxes (other major sources are payroll and corporate taxes-- total revenue is about 3.4 trillion) largest spending item is SS (then medicare and medicaid)

What's the short-run Phillip's curve? What policy does it imply?

Inflation inversely related to Unemployment This seems to imply a possible short-run trade off between inflation and unemployment; i.e., policy makers can choose to reduce unemployment at the cost of additional inflation

What was Bretton Woods?

International conference after WWII which established a fixed exchange rate system for the major currencies that lasted until the early 1970s

Why is the LR Phillip's curve vertical and what does it imply for policy?

Long-Run Phillips curve Vertical (at NAIRU) - cannot lower unemployment rate below natural rate in the long run, and if attempt to do so, more inflation only No 'trade-off' between inflation and unemployment in long-run, only more inflation Why vertical - sr phillips curve shifts up (to the right) as expectations of inflation increase

What is hidden unemployment, discouraged workers?

Marginally attached workers currently want a job, have looked for work in the last 12 months and are available for work. "Discouraged workers" believe no job is available to them in their line of work or area. had previously been unable to find work. lack the necessary schooling, training, skills, or experience. face age or other Hidden Unemployment (underemployed) hidden - Hidden unemployment refers to people who are jobless, but official unemployment figures do not include them

Who were the Luddites (very simply) and why do they matter now?

The original Luddites were British weavers and textile workers who objected to the increased use of automated looms and knitting frames. Most were trained artisans who had spent years learning their craft, and they feared that unskilled machine operators were robbing them of their livelihood For example, the report suggests that we're going to be seeing a lot of "automation of knowledge work," with software doing things that used to require college graduates. Advanced robotics could further diminish employment in manufacturing, but it could also replace some medical professionals.

How do we measure the level of prices (what indices-CPI, Implicit GDP deflator)?

The price level is examined through a "basket of goods" approach, in which a collection of consumer-based goods and services is examined in aggregate; changes in the aggregate price over time push the index measuring the basket of goods higher CPI=cost of market basket in given yr/cost of....base yr * 100

Why do we have a capital/financial account surplus and what does it imply?

Thefinancial account measures net financial inflows - a financial account surplus means that foreigners are buying more of our real (factories) and financial (stocks, bonds) then we are buying of theirs. Thus we are growing poorer or going in debt to them Surplus 'Bad' since foreign ownership of U.S. assets increasing (foreign funds flowing in to buy assets)

What can cause inflation in the long-run?

Too rapid growth in the money supply

What is meant by Trickle-down economics

Trickle-down economics, or "trickle-down theory," states that tax breaks and benefits for corporations and the wealthy will trickle down to everyone else. It argues for income and capital gains tax breaks or other financial benefits to large businesses, investors and entrepreneurs to stimulate economic growth. The argument hinges on two assumptions: All members of society benefit from growth, and growth is most likely to come from those with the resources and skills to increase productive output.

What were Tulip Mania, the South Seas Bubble, the Dot com bubble, the 21st century housing bubble (subprime crisis)

Tulip Mania - 1637 Tulip Mania - speculative bubble Netherlands, tulip prices rose to 10x annual incomes, then collapsed South Seas Bubble 1720 South Seas Bubble, stock speculation in British stock company Company established to fund gov't debt 10 fold increase in stock price in year Dot com bubble 2001 - The dotcom bubble was a rapid rise in U.S. equity valuations fueled by investments in Internet-based companies during the bull market in the late 1990s. During the dotcom bubble, the value of equity markets grew exponentially, with the technology-dominated NASDAQ index rising from under 1,000 to more than 5,000 between 1995 and 2000. subprime crisis - The subprime meltdown was the sharp increase in high-risk mortgages that went into default beginning in 2007, contributing to the most severe recession in decades. The housing boom of the mid-2000s - combined with low interest rates at the time - prompted many lenders to offer home loans to individuals with poor credit. When the real estate bubble burst, many borrowers were unable to make payments on their subprime mortgages.

What fiscal policy actions? GR

Under President Bush and Treasury Secretary Paulson, the TARP 'spending' program which provided loans and other support to major banks and later to GM and others. Under Obama, ARRA - American Recovery and Reinvestment Act - a mixture of tax cuts and government spending programs to boost aggregate demand

How did the gold standard affect exchange rates? Balance of payments?

Under the gold standard (late 19th, early 20th century) many countries set their currencies equal to a fixed weight of gold. This means that these countries had a fixed exchange rate against other countries. If US$=35 ounces of gold and the British pound was worth 175 (hypothetical) then 1GBP = $5, Under fixed exchange rates, gold would flow in or out of a country to correct trade deficits and lead to an automatic adjustment Price-specie automatic adjustment-Hume Curr Acct deficit- X>M ->Gold Ouflow->Ms falls->Prices fall->X up, M down-> deficit ends

How do we define the unemployment rate? The Labor Force participation rate?

Unemp rate=Unemp/(Emp+Unemp) =Unemp/Labor Force The labor force participation rate measures an economy's active labor force and is the sum of all employed workers divided by the working age population. Labour force participation rate is defined as the section of working population in the age group of 16-64 in the economy currently employed or seeking employment. (The civilian labor force is a term used by the Bureau of Labor Statistics to refer to Americans whom it considers either employed or unemployed)

What's the relation between wages, prices and productivity?

W/P=MP or W=PxMP and %change W = % change P + % change MP

How do exports and imports affect the macroeconomy in the SR?

X increases aggregate D, M reduces it (D=C+I+G+X-M) determinants of X - $, foreign income - note using $ to mean dollar exchange rate with other currencies; example # yen per dollar determinants of M - $, domestic income

What harm do Long-run Government Budget Deficits cause?

crowding out of possibly more productive private sector investment and thus slower growth, increased foreign obligations

What does it take to be counted as unemployed?

have to be out of work, available to work and be actively seeking a job