macro 3

Paul Volcker

1970's chairman of Fed Sharp increase in interest rates to cause short-run recession but lower inflation in the medium-run

Milton Friedman

Augmented Phillips Curve bc tradeoff of unemployment and inflation will disappear Modern theory of consumption: people make decisions not on current income but permanent, life income Activist policy: does more harm than good

John Maynard Keynes

Focused on equilibrium of investment and saving in goods market Book on General Theory: aggregate demand determines output Liquidity preference: demand for money

Janet Yellen

Menu cost: cost of changing a price Was a fed chair

Paul Samuelson

Original phillips curve Neoclassical synthesis: integrated Keynes' ideas Introduced calculus 2 Founder of modern economics in the US**** (most important point)

Depending on the model used, a one percentage point reduction in the policy interest rate is estimated to increase output growth in the year of the interest rate cut by as much as 2.1 percentage points

True, in cases like the Great depression and both World Wars government expenditures increased substantially and tax were not increased proportionally leading to an increase in debt to GDP ratio. Those wide fluctuations of debt to GDP were caused by massive increases to government expenditures in times of economic distress.

Depending on the model used, a one percentage point in the reduction in the policy interest rate is estimated to increase output growth in the year of the interest rate cut by as little as 0.1 percentage points

True, it is the difference government spending and taxes when the difference negative.

The IS curve shifts up with an increase in G, up with an increase in T and up with an increase in X

a. False. The IS curve shifts right with G, left with T and left with x.

The deficit is the difference between real government spending and taxes net of transfers

a. False—The difference between real government spending and tax is the primary deficit (see part b.). The entire deficit also includes real interest payment on government debt.

The most important argument in favor of a positive rate of inflation in OCED countries is seignorage

a. False—The most important argument for a positive inflation rate is monetary policy flexibility; with inflation, there is more "room to use monetary policy (p. 487)." Seignorage is very small in OECD countries.

There is so much uncertainty about the effects of monetary policy that we would be better off not using it

a—False—The uncertainly is in the speed and duration of the impact, not in the effect (direction of the impact). Monetary policy is useful in making recessions less severe.

If (U- Un) is greater than 0, (Y - Yn) is greater than 0

b. False. If the observed unemployment rate is greater than the natural rate, the output gap is negative because labor is used inefficiently.

The price of food is higher in poor countries than it is in rich countries.

b. False—"[T]he prices of basic goods" (p. 201) are lower in poor countries. WHY?

Fighting inflation's should be the Fed's only purpose

b. False—Getting inflation right does not automatically put the economy at potential output. While it is important to fight inflation, there are times when other concerns, such as preventing a world-wide depression, are more pressing. The Fed is mandated to pursue three goals: "maximum employment, stable prices, and moderate long-term interest rates." This is the Fed's dual mandate. While the last quote from the Humphrey-Hawkins 1978 Act is no longer in the text, macroprudential regulation is. Its goal is to maintain a healthy financial sector to keep the economy stable (= near potential of output). In the short run, the Fed affects unemployment and output.

The primary deficit is the difference between real government spending and taxes net of transfers

b. True—That is the definition of primary deficit.

Inflation and money growth moved together from 1970 to 2009

c. False—Inflation and M1 (money) growth (see Figure 32-1 on p. 480) have not moved together. Specifically, the difference in the 10-year averages was high around 1990.

If (U - Un) is equal to 0, the output is at potential

c. True. This is true because Yn is defined as the output associated with the natural rate of unemployment. Yn is also called potential output. See p. 179.

evidence suggests that happiness in rich countries increases with output per person

c. True—Look at Figure 1 (p. 204), especially as regards the Stevenson and Wolfers study that is illustrated in Figure 1. Note that income on the x-axis is recorded using a logarithmic scale. Across countries, including rich countries, happiness rises with income. The dash trough each dot indicates that the same relationship holds within countries.

The US has experienced wide fluctuations in the ratio of debt to GDP in the past century

c. True—The large fluctuation in B/Y was demonstrated in Figure 21-4 (p. 444).

If (U - Un) is less than zero, then (Y - Yn) is greater than zero

d. False. If the unemployment rate is higher than normal, less than potential output is produced.

Because most people have little trouble distinguishing between nominal and real values, inflation does not distort decision making

d. False—Most people have a hard time distinguishing nominal and real amounts—they suffer from "money illusion," which distorts their decision making. See Focus on p. 485.

in virtually all the countries of the world, output per person is converging to the level of output per person in the USA

d. False—There are lots of countries in Africa, for example, whose output per person is stagnant or even falling! (Recall I mentioned "divergence" in class.) It does not approach the US income. But output per capita converges in many countries, especially in Europe.

Tax smoothing and deficit finance help spread the burden of war across generations

d. True—These are the two major reasons why countries should not burden the current generation with war finance. First, since the future generations benefit as well, they should bear part of the cost. That cost comes in reduced capital stock in the future. Capital stock is lower because higher G (spent on national defense) increases the interest rate and reduces private investment. Second, if tax rates are greatly increased, current economic activity that is taxed is disproportionately reduced. Blanchard suggests that such a tax-rate increase leads to distortions, such as black and grey market activity. Tax smoothing avoids such distortions. See pp. 465-6.

Elect a Democrat as president if you want low unemployment

d—True—Table 21-1 indicates that Democratic administrations are associated with higher growth on average and thus with greater decreases of the unemployment rate (3.9%>3%). (Recall Okun's law.)

Most central banks around the world have an inflation target of 4%

e. False -Most banks have a 2% inflation target (p. 487). Please be able to explain why.http://www.federalreserve.gov/newsevents/press/monetary/20120125c.htm

The government should always take immediate action to eliminate a cyclically adjusted budget deficit

e. False—Blanchard argues that "[i]n a recession, the government may want to" give the economy an extra boost to help it recover and thus create structural deficits (p. 463). This is in addition to the deficit that occurs "automatically" in a recession. (A 1% drop in income generates a .5% increase in deficit -measured as a percent of GDP; p. 464) Make sure you can explain why deficits rise in a recession.

If the output gap is positive, inflation is higher than expected inflation

e. True. This is illustrated by the PC curve (Figure 9-1).

for about 1000 years after the fall of the Roman empire there was essentially no growth in output per person in Europe because any increase in output led to a proportional increase in population

e. True—This is what Thomas Robert Malthus observed. People lived at subsistence level. See the extra question below. If two variables grow at the same rate, their ratio stays constant.

There is clear evidence of political business cycles in the US; low unemployment during election campaigns and high unemployment the rest of the time

e—False—"There is little evidence of manipulation...of the economy to win elections (p. 445)."

Okun's law says that if output growth increases by one percentage point, the rate of unemployment drops by one percentage point

f. False. For every one-percentage point increase in growth, the unemployment rate drops by .4%.

If Ricardian equivalence holds, then an increase in income taxes will affect neither consumption nor saving

f. False—An increase in income taxes (that is accompanied with lower future taxes, for example next year) does not affect consumption, but it decreases private saving. This is the opposite of the argument on p. 462. Consumers realize that higher taxes today mean lower taxes tomorrow, and their human wealth is the same regardless of the timing of the tax increase: the present value of taxes is the same regardless of financing. Since public saving is rising, private saving is falling, leaving total saving unchanged. Private saving decreases because it will increase once taxes fall in the future. In short, people dissave as they anticipate lower taxes in the future.

The higher the inflation rate, the higher the effective tax rate on capital gains

f. True—As the inflation rate rises, so does nominal wealth. Since taxes are imposed on nominal amounts, the effective rate rises. See p. 484—and problem 7 below.

capital accumulation does not affect the level of output in the long run; only technological progress does

f. True—Capital accumulation raises output—countries with higher capital per worker will have a higher output per worker. But capital accumulation cannot create rising output per worker in the long run, because of decreasing returns to capital. Only technological improvement can sustain growth by raising the production function.

Fiscal spending rules in the US have been ineffective in reducing budget deficits

f—T/F/U—Rules can be effective, but they are not as effective as people think because policy makers can break them—see p. 449. You could say that in the long run, rules are thus ineffective. (Odysseus can ask to be untied...)

The ratio of debt to GDP cannot exceed 100%

g. False—We have seen several examples of national debt exceeding 100% of GDP: The US and other countries after WWII (pp. 444 and 470) and UK after the Napoleonic wars (p. 471). Gross national debt in Japan is currently over 200% of GDP.

At the natural rate of unemployment, inflation is neither rising or falling

g. True. This is the best seen from equation 8.10 (p. 165).

the aggregate production function is a relation between output on one hand and labour and capital on the other

g. True—This is the definition of the production function.

The Taylor rule describes how central banks adjust the policy interest rate across recessions and booms

g. Uncertain—The Taylor rule describes how the Fed adjusts the nominal interest rate in response to deviations of the inflation rate from the target inflation rate and the unemployment rate from the natural unemployment rate. The deviations may result from booms and recessions.

Balanced budget rules in Europe have been effective in constraining budget deficits

g—False—The EU has not enforced the penalties is imposed for breaking budget rules. Thus, in recessions many countries had deficits in excess of 3% of GDP and the debt/GDP ratio has grown beyond 60%.

The zero lower bound on the nominal policy rate was expected to be a regular feature of monetary policy when inflation targeting began

h. False—When the inflation targeting began in the early 1990, inflation was higher than today and the liquidity trap (zero lower bound) was just a theoretical possibility (discussed by Keynes, btw.)

In the medium run equilibrium, the rate of unemployment is stable

h. True. That is all we can say. Inflation is unchanging in the medium run, but we do not know at what rate.

A haircut reduces the value of outstanding government debt outstanding

h. True—A hair cut reduces the face value of outstanding bonds, which make up government debt.

Government would be wise to announce a no negotiation policy with hostage takers

h—True—A policy of never negotiating with hostage takers will minimize the number of hostages taken. Even more importantly, the government should follow this announced policy to demonstrate its credibility. (But note problem 3 below—this policy is not costless.)i

The central bank can always act to keep output equal to potential output

i. False. Unfortunately, the central bank cannot always keep the economy at potential (aka full) output. The reasoning is on p. 182. You can also add the observation on p. 183. When inflationary expectations are based on past inflation, then the central bank may have to create a recession to reduce the medium-run inflation rate to an acceptable rate.

The cyclically adjusted deficit is always smaller than the actual deficit

i. False—In an expansion, when the economy is beyond potential output, the cyclically adjusted deficit is larger than the actual deficit. Make sure you understand the concept of a cyclically adjusted deficit. That is the deficit that would prevail under current fiscal rules if the economy were at potential output.

Quantitative easing refers to central bank purchases of assets with the intention of directly affecting the yield on these assets

i. True—That is the explanation/definition (p. __)

If hostages are taken, it is clearly better to negotiate with hostage takers, even if the government has announced a no-negotiation policy

i—False—While negotiating may save the current hostages and be a good short-run policy, it is not a good long-run policy. Breaking a commitment will encourage more hostage taking in the future. Also see Problem 3 below.

The inflation adjusted deficit is always smaller than the actual deficit

j. False—While the inflation-adjusted deficit is smaller than the actual one in Figure 1, it seems to be the same in year 2009. If there is deflation, then nominal values are lower than real values; the real interest rate exceeds the nominal interest rate.

It is easier for the central bank to keep output at potential output if expectations of inflation are anchored

j. True. If expectations are anchored then the bank does not have to create a recession to keep inflation stable.

In the crisis, central banks provided liquidity to financial institutions they did not regulate

j. True—That just shows how deep the crisis was.

There is some evidence that countries with more independent central banks have generally lower inflation

j—True—This is reflected in Figure 21-3. Note the warning in the margin about causality

When the ratio of debt to GDP is high, the best policy is a fiscal consolidation

k. False—Fiscal consolidation is not the best policy when the debt to GDP ratio is high because it creates a recession and raises the deficit and national debt. This policy was followed in Greece. "There is no easy solution." (p. 469). Also read p. 471.

One consequence of the crisis was higher capital requirements and a more extensive regulatory regime for banks

k. True—These regulations were put in place to make banks safer.

In a starve the beast fiscal policy, spending cuts come before tax cuts

k—False—"Starve the beast" policies hope that cutting taxes will create deficits and scare politicians to limit government spending (p. 445--margin)

A hyper inflation is an inflation rate greater than 30% per month

l. True/False—Hyperinflation does not have such a specific definition, but your book offers 30% as a possible "benchmark" for hyperinflation. Hyperinflation is "very high inflation."

Hyperinflation may distort prices, but they have no effect on real output

m. False—Hyperinflation affects real output negatively by making transactions very costly, distorting price signals, and reducing borrowing and lending (as the real interest rates become more and more unpredictable). There is "a large decline in investment." See p. 470.