Macro Final

Be clear on what we are referring to when we talk about "The Fed." Who are the main decision makers at the Fed?

"The Fed" is the Federal Reserve. The Federal Open Market Committee and Janet Yellen is the head of this committee. This committee decides the federal funds rate.

The main justification for cyclical deficits comes from the "functional finance" approach. The overall approach here is not to think of government deficits as necessarily either good or bad, but to ask the question: What function are the deficits serving? Are the deficits being put to good use?

-Functional finance is the basic case for cyclical deficits. It considers the national income identity, saying that consumption depends on national income and private investment is volatile. If the economy is moving into a recession, the only way to break the downward cycle is more government spending or more net exports. Functional finance believes in pumping up government spending to fight recessions.

Two perspectives other than "functional finance" on the governments running fiscal deficits are the doctrine of "sound finance" and the "Ricardian Equivalence" theory. Be clear on what these mean. In both cases, they would argue against the government running deficits. But what are their arguments? In what ways do they differ from the functional finance perspective?

-Sound finance argues that deficits should always be balanced, except during wartime. It believes that politicians should not be trusted with money, and that government spending inhibits private sector growth. They want the government to balance books "like households," and that big deficits during recession will cause high inflation, high interest rates, and an overwhelming debt burden. Ricardian Equivalence believes that individuals should increase savings in response to higher fiscal deficits. We should recognize future tax liabilites, since deficit spending has no positive benefits. These differ from the functional finance perspective because they both hold the opposite opinion that deficit spending has negative effects, while functional believes it's one of the only ways to climb out of recession. At the end of 2007, the 10 largest banks in the United States were all deemed to be in perfectly good shape. By 2008, we knew that wasn't true, the economy was tanking and the banks were falling apart. In order to save the economy, functional finance was put in place. Functional finance is a stimulus policy that rapidly increased government spending by borrowing the money to stimulate the economy. Considering national income identity (Y ≡ C + I + G + (X -M)), if the economy is moving into a recession, consumption (C) and private investment (I) both drop. Consumers spend less because there is a fall in confidence. They rather save then spend to feel secure. Private investments fall because businesses are afraid to invest. This lowers GDP meaning the government must find a way to counteract the recession. There are two possible ways to "break downward the vicious cycle". The government can either increase government spending (G) or try to increase net exports (X-M). The government has full control on their spending but not full control on net exports. Therefore, increasing government spending is the most efficient way to increase national GPD and fight the recession.

We have gone over how the current monetary policy stance at the Fed has been extraordinary in historical terms, because the Fed held the Federal Funds interest rate at close to zero for nearly 7 1/2 years. The Fed is currently slowing raising the Federal Funds rate, but only very modestly. What is the purpose of this policy?

-This slows the economy down a bit by increasing the federal funds rate (interest rates). This is to avoid an increase in inflation and to keep unemployment stable.

The late Professor Vernon Ruttan asks the question, "Is war necessary for economic growth?" His answer was "Yes." What specifically did he mean by this?

-what Professor Vernon Ruttan means by saying that war is necessary for economic growth is that industrial policy is necessary. When the US has implemented a military based industrial policy, major industries have emerged from military spending like jet aviation, nuclear energy, space industries, the computer, and the internet. Forms of military based support, such as guaranteed markets, also arise. Ruttan did not mean that war is necessary for economical growth but that industrial policy is and it is carried out by the US defense system. Industrial policy consists of policies that promote technological developments. Many people oppose industrial policy but we actually do it threw the military therefore being called military policy. Some technological research is too risky for private sectors to try because private secures need return and it can take years to develop a new technical advancement, so private sectors are not interested. The military is not at any risk of going out of business so they are able to work on new advancements without the fear of failing. Most if not all innovations that were relevant for business development happen threw the U.S. pentagon, such a nuclear energy, computers, information technology

Two factors have contributed to making this most recent financial bubble and crash bigger than previous ones: 1) rising inequality in the U.S. economy; and 2) Deregulation of U.S. financial markets. How have these factors contributed to the crisis?

1.)Rising inequality gives too much power to the top to support financial speculation and gives too little money to promote broad market demand and business expansion 2.) financial deregulation is an effort by democrats and republicans to overlook the lessons of the past.

The Fed's mandate is to maximize employment in a manner consistent with price stability. The Fed's main policy tools are to: 1) lower or raise the Federal Funds interest rate; and 2) lender of last resort policies. Be clear on what both of these policies are and how they differ.

1.)lowering the federal fund rate lowers all rates and hopes to stimulate business investment.Raising federal rates aims to slow down business investment and slow down a boom that may be too risky and excessive 2.)Lender of last resort is when the economy is failing they have the power to put money from the federal reserve back into the economy to keep it functioning. During the recession they bailed out banks and made sure the banks stayed operating.

In 2007 - 09, the U.S. and global economy experienced the most severe financial bubble, collapse, and crisis in 70 years. Be clear on the basic dynamics driving a financial bubble. Why can financial bubbles be self-reinforcing? Why do they collapse?

Basic pattern: "Overleveraging" Borrowing too much in pursuit of new profit opportunities Creates self-reinforcing bubble Crisis begins when bubble bursts Bundled homes together to make them seemingly more affordable and gave faulty loans that people would not be able to pay back and then many homes went up for foreclosure and banks started to fail because no one was paying their mortgages.Self-reinforcement is a process whereby individuals control their own behavior by rewarding themselves when a certain standard of performance has been attained or surpassed. Similarly financial bubbles continue to grow as long as people believe in them even if they may be faulty they continue to grow until eventually they burst because the gap has caught up with them.

Within the context of functional finance, what is the justification for the government running deficits during recessions, such as the one we experienced over 2007-09?

Countercyclical policy attempts to smoothen out peaks and troughs of the economy. When times are good, the government cuts back on spending, but in times of economic turmoil, the government increases spending and cuts back taxation. By doing this, the government deficit goes up, but it is necessary when the economy is in bad shape.

Be very clear on key categorical distinctions/definitions. Understanding them is not a matter of mere word games, but of understanding the issues at hand. The key definitions to know are: Deficits vs. accumulated debt, Cyclical vs. structural deficits

Deficits vs. accumulated debt Deficit: are flows, how much the government borrows over a given time Debts: are stocks, how much you add up every year by the increments of the deficits. Debt is about 70% of GDP. Cyclical vs. structural deficits Cyclical: Gov. borrowing money to counteract recession. Structural: Gov. borrowing money not to counteract recession but to improve the structure of the economy. Deficit is the difference between the amount of the money the government takes in from taxes and other revenues and the amount of money the government spends. It is a flow of what the government borrows in one year. Accumulated debt accounts for all of the money owed overall, while deficit is just an annual difference. It is the stock, and debt burdens are annual repayments of interest on debt. A structural deficit is the deficit over a full cycle, while a cyclical deficit is the approximate balanced budget over a full business cycle. It grows in recession, but becomes a surplus in expansion.

What is your assessment as to how well these various efforts worked to get the economy out of the crisis?

I think it was important for governments to get involved and bailout the big banks because we needed to keep the economy going so businesses had a chance to recover. I think that we should focus more on investing in green energy, infrastructure and education because these are long term stabilities for the economy. We should also focus less on getting rid of immigrants because they do not have as big of an impact on unemployment as people may think.

Has the rise of China as an export powerhouse been detrimental in any way to working people in the U.S.? If so, how; and if not, why not?

If China's products are cheaper people will buy it over American made products, which are more expensive. This creates fewer jobs in the US and scares workers. Global trade in general but specifically with China has expanded the reserve army of labor. Workers are unable to bargain their wages because their employers can just go to cheaper sources. This happens even at low unemployment.

Be sure to understand the role of exchange rate issues with respect to China and the US, and more generally. How does having a "cheap" currency help a country export? How could China continue to help keep its currency value low?

If currency rises that means it would be more expensive to buy goods, which in turn decreases demand. China wants to keep their demand high for exports and they do so by manipulate their currency. China's goal is to have one US dollar be equivalent to a lot of Yuan's. To buy Chinese product, America first has to buy Yuan's, which in turn drives up the demand and then the value of a Yuan. When the value of the Yuan goes up so does the price of the goods, decreasing demand. To counteract this, China drives up the value of the dollar. China buys bonds with US dollars, forcing up the value of the dollar.

Consider the decade of the 1970s. What could explain the relationship between unemployment and inflation that we observe then, relative to the relationship we observe for the 1950s and 1960s?

In the 70s, both inflation and unemployment were high because of surge in oil prices. The surge in oil prices caused the price of goods and services to also increase causing inflation. To cut costs companies laid off/fried employees increasing unemployment. In the 50s and 60s, unemployment was low and inflation was high

Consider the 1990s: Then Federal Reserve Chair Alan Greenspan hypothesized that the U.S. workers had become "traumatized." If Greenspan's observation is accurate, why might that influence the inflation/unemployment trade-off, both in the 1990s and more generally?

In the 90s, both inflation and unemployment were low. There were more technological advancements, which made people feel replaceable. Globalization also became a problem, it was easier for companies to up and move to another country. This meant that workers felt replaceable and become "traumatized workers". Even at low unemployment, these workers had no job security making them unable to barging up their wages. Without workers bargaining up their wages, inflation also stayed low.

What is industrial policy? What are the main features of industrial policy that have contributed to the strong economic growth performance of some Asian countries such as, initially, Japan, then South Korea and China?

Industrial policy is the research/development, commercialization, and adaptation of technology. The government's purpose is to serve the public interest to advance the state of technology and adapting technology to make it more marketable. The main feature of industrial policy that has contributed to the strong economic growth performance of some Asian countries are their practice of industrial policy in combination with markets.Their governments actively supported the development of technology so they are be able to produce thing other countries want to buy. The government supported the companies by subsidizing at cheap rates to companies that can prove that they can export. Japan used industrial policy to learn to build better cars that the US would want to purchase which benefited private companies. As soon as a country become successful in trade and industrial policy their currency goes up forcing them to have to intervene to drop the currency to keep their products cheap and demand high.

It is also a widely held view that immigrants living in the U.S. are absorbing a significant share of the economy's available public services, without paying a proportional share of taxes to support these services. On balance, what does the evidence on this issue find?

It is false to say immigrants living in the U.S. are absorbing a significant share of the economy's available public services, without paying a proportional share of taxes to support these services. Undocumented workers don't not use a significant share of the economy's public services because they are undocumented. These workers are not taking any of their benefits. These undocumented workers are contributing to social security trust funds because they are taxed at jobs. They also pay sales tax on anything that they purchase but do not receive health care benefits.

Using the tools available to them, how might it be more difficult for the Fed to maintain control over inflation and unemployment when financial markets are unregulated?

It may be difficult for the Fed to maintain control in an unregulated market because Maximum employment, stable prices, moderate interest rates are all related. The federal reserve needs to control inflation because changes in inflation relate to changes in bargaining power and workers cannot have too much bargaining power because then policies become more difficult

Rich, poor and middle-income countries: Be clear on some of the major differences between countries in terms of what the average person in each category of country can expect.

Life opportunities are dramatically different depending on where you're born. Avg. income in Haiti is around $700 a year with a life expectancy 55-60. Compared to Sweden where the avg. income is around $55,000 yearly and life expectancy of 80. There are countries in the middle, ex. Iran, avg. income is roughly $7000 with a life expectancy of 70.

As a share of U.S. GDP, the federal government's fiscal deficit reached its highest level since World War II between 2009-12. What is the explanation for deficits at this level?

The Great Recession was the reason for this deficit, as the government was forced to significantly increase spending to try and aid the economy in recovering from the recession. The government had to spend a significant amount of money on food stamps and similar programs, bailouts, and a stimulus package, while taking a hit in tax revenue.

Be clear on where the U.S. stands in the global economy. How big is the U.S. economy as a share of the global economy? How important is the U.S. in terms of population? In terms of addressing climate change?

The US is about 20% of global GDP, 5% of global population, and 15% share of total greenhouse gases. We are polluting the world about 3 to 4 times more than the rest of the world.

How did the government try to get out of the crisis using monetary policy, fiscal policy, lender-of-last-resort and financial regulatory policies?

The government borrowed from the fed so they can spend to stimulate the economy. The fed changed the money supply which is monetary policy by creating more of it to be available to the public. The fed also made fiscal policy by keeping interest rates low. As a lender of last resort the government bailed out banks that were deemed too big to fail and the fed bought $1.25 trillion in market backed securities. This was so the banks could get back on their feet. As for financial regulatory policies the government enacted the Dodd-Frank which was created to regulate banks so a crisis like the recession would never happen again.

What is the law of comparative advantage? Following the law of comparative advantage, why would any given country seek to specialize in producing one or two products and importing everything else they need, rather than diversifying?

The law of comparative advantage encourages countries, regions and people to specialize enable to produce goods and services at a lower opportunity cost than other country, region or people. Any given country would seek to specialize in producing one or two products and importuning everything else they needed rather than diversifying to be able to produce more of all goods and then trade them with other countries so everyone has more of everything. In the case of Pakistan and Belgium, Pakistan has comparative advantage in textiles and Belgium has comparative advantage in chocolate. Pakistan can produce 4,000 yards of textiles or 1 ton of chocolate per day, while Belgium can produce 1,000 yards of textiles or 4 tons of chocolate per day. To maximum the production of both textiles and chocolate, Pakistan and Belgium must follow the law of comparative advantage and produce what they are best at to produce more and then trade.

China's successful growth experience since the early 1980s has been closely tied to its achievements as an exporter, with the United States being the largest single purchaser of Chinese-made products. What have been the main factors behind China's success in exports?

The main factors behind China's success in exports is keeping their currency cheap, having cheap labor and producing goods that people want to buy at mass quantity at low costs. China is considered to be a currency manipulator because they have maintained their currency at low level to keep price of exports low in other foreign markets. Also, low wage labor and investment into infrastructure assisted with their success in exports.

Evidence on inflation/unemployment trade-off: Is it accurate to say that there is always a trade-off between unemployment and inflation? Compare evidence on a decade-by-decade basis. What do the patterns show?

The relationship between unemployment and inflation is unstable. Both low in the 90s. Both high in the 70s. When unemployment is low and inflation is high, workers have more bargaining power which drives up wages also driving up prices of goods and services. The Philips curve shows this relationship. Based on the data on the phillips curve it shows low unemployment doesnt bring high inflation.

It is a widely held view among some politicians and authors (e.g. Camerota, NY Times) that immigrants in the U.S. labor market hurt job prospects for native U.S. workers. Why might this be the case? On balance, what does the evidence on this issue find?

There is mixed evidence on whether immigrants in the US labor market hurt job prospects for native US workers. Many claim that the increase in labor supply pushes down wages but when studies were conducted there was no evidence of downward pressure. Immigrants increase demand because there is more spending in the economy. This leads to more need in labor which driving up wages.

While the fiscal deficit reached an historic high over 2009-12, government interest payments as a share of overall government spending remained historically low. How could this be possible? Why has it happened?

This was possible because the fed kept these interest payments low.The fed kept interests low by creating money. If you makes more funds available to the public you keep interest rates low. The Fed lends to the government so the government can spend to stimulate the economy and the government pays interest to the fed. They create money and keep the interest rates low. This happened so the government could practice functional finance and not have to pay high interest rates.

What would be reasons for the Fed to be raising the Federal Funds rate now? Is there a relationship between their most recent actions, and their understanding of the concept of the "natural rate of unemployment?"

We are currently not at a point where the inflation is increasing, and Janet Yellen is guessing that we are close to the point where inflation will rise. The "natural rate of unemployment" is the point where unemployment rates are as low as possible without an increase in inflation, so yes there is a relationship.

If we consider the cases of South Korea and China, is it accurate to say that their successful growth experiences have been tied to the idea of comparative advantage? In this context, be able to distinguish between "static" and "dynamic" comparative advantage.

Yes, it accurate to say that their successful growth experiences have been tied to the idea of comparative advantage. South Korea and China "nurtured" what they wanted to me good at, in this case cars. If they had never diversified they would have never become good at producing high demanded cars. By using dynamic comparative advantage they produced things that did not define their economy (static). By taking the dynamic approach these countries became successful at exporting manufactured products. South Korea and China's living standards increased because they ignored the static approach and pursued industrial policy.

On April 13, Professor Noam Chomsky spoke at the Mullin Center on "Prospects for Survival." Be familiar with the main arguments he raised in particular on climate change as one extra credit question for the exam.

simple initiatives that are easily undertaken like weatherizing homes (which could also create many jobs), to entirely new forms of energy, perhaps fusion, perhaps new means of exploiting solar energy outside the Earth's atmosphere (which has been seriously suggested), to methods of decarbonization that might, conceivably, even reverse some of the enormous damage already inflicted on the planet. Rapid ending of use of fossil fuels, sharp increase in renewable energy, research into new options for sustainable energy, significant steps toward conservation, and not least, a far-reaching critique of the capitalist model of human and resource exploitation