macro 2

The nominal interest rate is measured in terms of goods; the real interest rate is measured in terms of money.

1.a. False. It is the other way around: Nominal rate is measured in terms of money and real rate in terms of goods.

As long as expected inflation remains roughly constant, the movements in the real interest rate are roughly equal to the movements in the nominal interest rate.

b. True. This follows from the concept of the real rate, which is the nominal rate minus expected inflation. If the latter is fixed, there is a one-to-one correspondence between the changes in the two rates.

Each month, the flows into and out of employment are very small compared to the size of the labor force.

b. True; see p. 139. "The flows ... are large relative to the number of unemployed." They are not large compared to employment. The flow is 5.7 (3.7+2.0) million into employment and 5.4 (3.4+1.8) million out of employment relative to average monthly employment of 139 million.

Fewer than 10% of all unemployed workers exit the unemployment pool each year.

c. False. About 44% exits the unemployment pool each month (see p. 139).

The nominal policy interest rate was at the zero lower bound in the United States in 2013.

c. True. See Figure 6-2.

For some periods of history, inflation has been very persistent between adjacent years. In other periods of history, this year's inflation has been a poor predictor of next years inflation

c. True—For example, "The rate of inflation became more persistent" (p. 161) in the 1970s after being unpredictable prior to 1960 (p. 160).

The unemployment rate tends to be high in recessions and low in expansions.

d. True. The unemployment rate moves counter-cyclically. Fewer workers are needed to produce goods in a recession and more workers are needed to produce goods when demand rises in an expansion.

When expected inflation increases, the real rate of interest falls.

d. True. This, too, follows from the concept of the real rate, which is the nominal rate minus expected inflation. If the latter rises—and the nominal interest does not change—the real rate falls.

Policy makers can exploit the inflation-unemployment trade-off only temporarily

d. True—the negative relationship between inflation and unemployment holds only in the short run as long as inflationary expectations are fixed. When rising unanticipated inflation reduces real wages, more workers are hired and the unemployment rate falls. (This is one of the mechanisms that generates the curve.) In the medium run, however, the natural rate of unemployment is consistent with any stable inflation and thus cannot be reduced by changes in inflation.

All bonds have equal risk of default and thus pay equal rate of interest.

e. False. Bonds have different riskiness (the best are rated AAA and the worst are rated C and below) and thus different yields. See Figure 6-3.

Expected inflation always equals actual inflation

e. False—actual inflation equals expected inflation only when the unemployment rate is at the natural rate.

For about 1,000 years after the fall of the Roman Empire there was essentially no growth in output per person in Europe because 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.

Workers who do not belong to unions have no bargaining power.

f. False. If workers have special skills, they have individual bargaining power.

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.

An increase in a bank's leverage ratio tends to increase both the expected profit of the bank and the risk of the bank going bankrupt.

g. True. Managers take on debt to raise the rate of return shareholders, but they expose them to the risk of bankruptcy if the value of assets falls. There is more income per share with fewer shares outstanding. But if total income is low and insufficient to pay debt holders, then the bank is bankrupt.

It may be in the best interest of employers to pay wages higher than their workers' reservation wage.

g. True. These higher wages are called efficiency wages, and they motivate employees to work harder.

The real borrowing rate and the real policy rate always move in the same direction.

h. False. Since the policy rate is set by the central bank the borrowing rate depends on the risk premium, which the bank cannot directly control (but see problem 9), the real policy and borrowing rates can move in opposite directions.

The natural rate of unemployment is constant over time within a country

h. False—within a country, he natural rate of unemployment varies over time because it reflects labor market characteristics (factors m, z, and alpha), which vary over time.

The natural rate of unemployment is the same in all countries

i. False—the natural rate of unemployment varies across countries because it is a reflection of labor markets, and labor markets function differently across countries. (Compare Denmark and Spain, for example.)

The fiscal stimulus program adopted by the United States in response to the financial crisis helped offset the decline in aggregate demand and reduce the size of the recession.

m. True. This is exactly how Blanchard presents the fiscal policy measures: they did not prevent the recession but they helped to avoid a depression.

The fiscal stimulus program adopted by the United States included a large increase in the deficit measured as a percent of GDP.

n. True. The fiscal policy measures were helpful and generated large deficits that accumulated to a high national debt. We will see this more in Chapter 22.

Since 1950, the participation rate in the United States has remained roughly constant at 60%.

1. a. False. The participation rate has been rising, as more women have been entering the labor force. The rate is about 2/3 (p. 138). Note, however, that it fell during the Great Recession, which the book does not say.

The original Phillips curve is the negative relation between unemployment and inflation that was first observed in the UK

1.a. True—the original Phillips is a simple trade-off between inflation and unemployment (when inflationary expectations were stable).Extra: Recall that the original curve was draw

If people assume that inflation will be the same as last year's inflation, the Phillips curve relation will be a relation between the change in inflation rate and the change in unemployment rate

g. True—that is the augmented Phillips curve that is represented by equation 8.6. If people expect a given rate of inflation, wages and prices will adjust accordingly, and there will be no change in the unemployment rate. According to part f above, the unemployment rate will change only if the there is an unexpected change in the inflation rate.

The natural rate of unemployment is unaffected by policy changes.

h. False. The natural rate of unemployment rate is very much affected by policy variables, such as unemployment benefits, minimum wages, and employment protection. Recall that it depends on the structure (institutions) of the economy.

Banks and other financial intermediaries have assets that are less liquid than their liabilities.

k. True. This is a characteristic - and function - of banks. They create relatively liquid assets for its depositors while holding relatively illiquid assets itself. This is why banks are fragile institutions.

On a logarithmic scale a variable that increases at 5% per year will move along an upward-sloping line with a slope of 0.05.

a. True—That is the nature of the logarithmic scale. The slope is the growth rate. See the Appendix.SKIP

The original Phillips curve relation has proven to be very stable across countries and over time

b. False—the original curve is not stable, as demonstrated by the US experience in the 1970s. The curve shifts with inflationary expectations over time. Moreover, it is different for different countries because they have different rates of natural unemployment.

In virtually all the countries of the world, output per person is converging to the level of output per person in the United States.

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.

Most workers are typically paid their reservation wage.

e. False. Workers get usually more than their reservation wage because they have bargaining power and employers offer efficiency wages.

In the late 1960's economists Friedman and Phelps said that policy makers could achieve as low of an unemployment rate as they wanted

f. False—Phelps and Friedman warned that policymakers that could not achieve any lowunemployment rate. Policy makers thought they could reduce unemployment at will, but rising inflationary expectations proved them wrong. There is always a natural rate of unemployment! The only way for policy makers to reduce unemployment is to "trick" people and increase the inflation rate beyond the expected inflation rate.

The nominal policy interest rate is set by the central bank.

f. True. The central bank is in charge of setting the level of interest rates.

It can be difficult to value assets of banks and other financial intermediaries, particularly in a financial crisis.

i. True. The book states that it is difficult for others to evaluate the value of a bank's loans because they do not have the relevant information on those loans. (p. 119). [In a financial crisis, it is difficult to evaluate the business prospect of a borrower in general.] Many banks had securitized securities, and since, practically speaking, no one knew what the underlying assets were, no one could evaluate the securities. (Recall that Michel Burry of The Big Short was an exception.) See p. 126.

When a bank has leverage and low liquidity, it may have to sell assets at fire sale prices.

j. True. In a financial crisis, to which this statement refers, when the assets of the bank are in question, depositors have a tendency to withdraw their money, especially if they see that the bank has low capital. If the bank has illiquid assets and must meet depositors request for funds by selling the assets, it will not get the full value because it must sell them quickly. See p. 119.

Deflation means that the rate of inflation is negative

j. True—deflation is defined as negative rate of inflation (p. 170)

House prices have risen constantly since the year 2000.

l. False. Wish it were so! Figure 6-7 illustrates the drop in housing prices after 2005.

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

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

The aggregate production function is a relation between output on one hand and labor and capital on the other.

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