ECON MACRO TEST 2
Based on the growth accounting equation, equal percentage increases in capital and labor will leave output per worker unaffected only if ak+an =
1
Higher saving rate means
higher capital-labor ratio, higher output per worker, and higher consumption per worker
Time to maturity - Because long-term interest rates usually exceed short-term interest rates,
a risk premium exists: the compensation to an investor for bearing the risk of holding a long-term bond
Which of the following best completes the definition of money as used by economists?
a special set of assets that are widely accepted as payments for goods and services.
During the period 1973-1975, the United States experienced a deep recession with a simultaneous sharp rise in the price level. Would you conclude that the recession was the result of a supply shock or a demand shock?
a supply shock, because if it was a demand shock, the price level would have declined
Endogenous growth theory attempts to
explain, rather than assume, the economy's growth rate - The growth rate depends on many things, such as the saving rate, that can be affected by government policies
An increase in population growth rate, n, causes long run output, consumption, and capital per worker to
fall more output must be used to equip new workers with capital leaving less output available for consumption or to increase capital per worker
In the quantity theory of money, velocity is assumed to be highly
stable
US has had ___ recessions usually lasting___ months
11 10.2
What is comovement?
Macroeconomic variables that tend to move in the same direction over time.
How is the price level related to nominal money demand?
They are directly related- the higher the price level, the higher the demand for money.
money has ____ risk level, return, and time to maturity
lowest
Asset market equilibrium—an aggregation assumption
- Assume that all assets can be grouped into two categories, money and nonmonetary assets • Money includes currency and checking accounts - Pays interest rate im - Supply is fixed at M • Nonmonetary assets include stocks, bonds, land, etc. - Pays interest rate i = r + πe - Supply is fixed at NM
Problems with the leading indicators
- Data are available promptly, but often revised later, so the index may give misleading signals - The index has given a number of false warnings - The index provides little information on the timing of the recession or its severity - Structural changes in the economy necessitate periodic revision of the index Research by Diebold and Rudebusch showed that the index does not help forecast industrial production in real time - In real time, the index sometimes gave no warning of recessions
• Should a policy goal be to reduce population growth?
- Doing so will raise consumption per worker - But it will reduce total output and consumption, affecting a nation's ability to defend itself or influence world events
Basic assumptions and variables of Solow Model
- Population and work force grow at same rate n - Economy is closed and G = 0
• In equilibrium, productivity improvement increases the capital-labor ratio, output per worker, and consumption per worker
- Productivity improvement directly improves the amount that can be produced at any capital-labor ratio - The increase in output per worker increases the supply of saving, causing the long-run capital-labor ratio to rise
The business cycle is _______, but not _______
- Recurrent means the pattern of contraction- trough-expansion-peak occurs again and again - Not being periodic means that it doesn't occur at regular, predictable intervals
The fundamental determinants of long-run living standards
- The saving rate - Population growth - Productivity growth
Velocity and the quantity theory of money
- Velocity (V) measures how much money "turns over" each period V = nominal GDP / nominal money stock = PY / M
Other factors affecting money demand
- Wealth: A rise in wealth may increase money demand, but not by much - Risk • Increased riskiness in the economy may increase money demand Liquidity of alternative assets: Deregulation, competition, and innovation have given other assets more liquidity, reducing the demand for money - Payment technologies: Credit cards, ATMs, and other financial innovations reduce money demand
Money demand affected by
-price level -real income -interest rates
Burns and Mitchell (Measuring Business Cycles, 1946) makes five main points about business cycles:
1. Business cycles are fluctuations of aggregate economic activity, not a specific variable 2. There are expansions and contractions 3. Economic variables show comovement—they have regular and predictable patterns of behavior over the course of the business cycle 4. The business cycle is recurrent, but not periodic 5. The business cycle is persistent
leading, lagging, or coincident 1. business fixed investment 2. residential investment 3. inventory investment 4. stock prices 5. money supply 6. nominal interest rates
1. coincident 2. leading 3. leading 4. leading 5. leading 6. lagging
All else being equal, how would each of the following affect the demand for M1? For M2? 1. The maximum number of checks per month that can be written on money market mutual funds (MMMFs) and money market deposit accounts is raised from three to thirty. 2. Home equity lines of credit that allow homeowners to write checks against the value of their homes are introduced. 3. The stock market crashes, and further sharp declines in the market are widely feared. 4. Banks introduce overdraft protection, under which funds are automatically transferred from savings to checking as needed to cover checks. 5. A crackdown reduces the illegal drug trade (which is carried out largely in currency).
1. decrease, no effect 2. decrease, decrease 3. increase, increase 4. decrease, no effect 5. decrease, decrease
2 major components of business cycle theories
1. description of shocks 2. how economy responds to shocks
According to the Solow model, how would each of the following events affect consumption per worker in the long run (that is, in the steady-state)? 1. The destruction of a portion of the nation's capital stock in a war: 2. A permanent increase in the rate of immigration (which raises the overall population growth rate): 3. A permanent increase in energy prices: 4. A temporary rise in the saving rate: 5. A permanent increase in the fraction of the population in the labor force (holding the population growth the same):
1. have no effect on the level of consumption per worker in the steady state. 2. This would decrease the level of consumption per worker in the steady state. 3. This would decrease the level of consumption per worker in the steady state. 4. This would have no effect on the level of consumption per worker in the steady state. 5. This would have no effect on the level of consumption per worker in the steady state.
What are the effects of each of the following events on output, the real interest rate, and current price level? 1. There is a temporary increase in government purchases. 2. There is a reduction in expected inflation. 3. There is a temporary increase in labor supply. 4. There is an increase in the interest rate paid on money.
1. no change in output; an increase in the real interest rate; an increase in the price level 2. no change in output; no change in the real interest rate; a decrease in the price level 3. an increase in output; a decrease in the real interest rate; a decrease in the price level 4. no change in output; no change in the real interest rate; decrease in the price level
U.S. research on cycles began in ______ at ______
1920 at the National Bureau of Economic Research (NBER) - NBER maintains the business cycle chronology—a detailed history of business cycles
output highest in _____ lowest in ______
4th 1st
The four characteristics of assets that are the most important to holder of wealth are
expected return, risk, liquidity and time to maturity.
Some economists argue that the U.S. saving rate is too low. Which of the following is a reasonable explanation for why the invisible hand of the market has failed to achieve a saving rate which optimally balances present consumption against future increases in living standards? A. Tax treatment of income discourages saving by taxing the returns to saving. B. Americans are predisposed to overweight the value of present consumption as compared to future consumption. C. The political process results in deficit spending that differs from public preferences. D. All of these are reasonable explanations.
All are reasonable
What are some of the reasons given why the U.S. experienced the large growth in productivity during the 1990's? A. the revolution in information and communications technologies (ICT) B. existing U.S. laws allowed firms to take advantage of the ICT improvements C. intangible investment (such as research and development, reorganization of firms, and worker training) allowed firms to take advantage of the ICT improvements D. All of the above have been cited as reasons to explain the increases in worker productivity.
All of the above
In endogenous growth theory the ________ affects long run growth rate (unlike in solow model)
saving rate
Rank the following assets in terms of liquidity, from the most liquid to the least liquid: a) Savings Account; b) Cash; c) Land; d) a U.S. Savings Bond
Cash; Savings Account; U.S. Savings Bond; Land
- The M2 monetary aggregate
M2 = M1 + less money like assets - Additional assets in M2: • savings deposits • small (< $100,000) time deposits • non-institutional MMMF balances • money-market deposit accounts (MMDAs)
Endogenous growth theory has constant
MPK Increases in capital and output generate increased technical knowledge, which offsets decline in MPK from having more capital
According to the Solow model, how would each of the following events affect long-run living standards? An increase in the savings rate would __________ long-run living standards. An increase in the population growth rate would ___________ long-run living standards. A one-time improvement in productivity would _________ long-run living standards.
Increase Reduce Increase
Which of the statements below, regarding the functions of money, is true?
Money serves as a medium of exchange, as a unit of account, and as a store of value.
How can saving be increased? •
One way is to raise the real interest rate to encourage saving; but the response of saving to changes in the real interest rate seems to be small • Another way is to increase government saving - The government could reduce the deficit or run a surplus - But under Ricardian equivalence, tax increases to reduce the deficit won't affect national saving
Quantity theory of money:
Real money demand is proportional to real income • Assumes constant velocity, where velocity isn't affected by income or interest rates
An increase in productivity causes long run output, consumption, and capital per worker to
Rise higher productivity directly raises output by raising income. also raises saving and capital stock
- Interest elasticity of money demand
Small and negative: Higher interest rate on nonmonetary assets reduces money demand slightly
___________________________ is the dominant factor determining how quickly living standards rise
The rate of productivity improvement
How is the level of real income related to money demand?
They are directly related- the higher the level of real income, the higher the demand for money.
How does the expected rate of return on an asset affect its desirability?
They are directly related - the higher the expected return, all else equal, the more attractive the asset.
How does the level of liquidity affect an asset's desirability?
They are directly related - the more liquid the asset, all else equal, the more desirable the asset.
How is the interest rate on other assets (stocks and bonds for example) related to money demand?
They are inversely related- the higher the interest rate on other assets, the lower the demand for money.
How does the level of risk affect an asset's desirability?
They are inversely related - the higher the level of risk, all else equal, the less attractive the asset.
Which of the following statements below describe what is meant by a steady state, in terms of the Solow model? (Assume there is no productivity growth)
Total output, total consumption and total capital all grow at the same rate (the growth of the labor force). Output per worker, consumption per worker and capital per worker are constant.
Why is equilibrium in the asset market described by the condition that real money supply equal real money demand?
When supply equals demand for money, demand must also equal supply for nonmonetary assets.
The ADS Business Conditions Index is
a coincident index based on variables of different frequencies
The CFNAI is
a coincident index produced by the Federal Reserve Bank of Chicago based on 85 macroeconomic variables - It is a coincident index that turns significantly negative in recessions
What are the two components of a theory of business cycles?
a description of shocks and how the economy responds to them
Higher population growth means
a lower capital-labor ratio, lower output per worker, and lower consumption per worker (Fig. 6.7)
How does the production function in an endogenous growth model differ from the production function in the Solow model? In the Solow model, the production function _____, while in the endogenous growth model, the production function _____.
exhibits diminishing marginal productivity; does not exhibit diminishing marginal productivity.
What two explanations of productivity growth does endogenous growth theory offer?
accumulation of human capital and technological innovation Your answer is correct.
Classical economists think that _____ shocks cause recessions, whereas Keynesian economists think that _____ shocks cause recessions.
aggregate supply; both aggregate demand and aggregate supply
Acid rain permanently raises depreciation rate and causes according to endogenous growth model growth rate of output growth rate of capital growth rate of consumption to
all decrease
A rise in the depreciation rate causes the steady-state capital-labor ratio to steady-state output per worker to and steady-state consumption per worker to .
all fall
A rise in the saving rate causes the steady-state capital-labor ratio to steady-state output per worker to and steady-state consumption per worker to
all rise
According to the Solow model of economic growth, if there is no productivity growth, what will happen to output per worker, consumption per worker, and capital per worker in the long run?
all stay the same
- Rate of return = • Bank account: Rate of return = • Corporate stock: Rate of return =
an asset's increase in value per unit of time interest rate dividend yield + percent increase in stock price
Which of the following would increase the public's expected rate of inflation? All else being equal, how would this increase in the expected inflation rate affect interest rates?
an increase in money growth increase the nominal interest rate
- The Conference Board produces
an index of leading economic indicators - A decline in the index for two or three months in a row warns of recession danger
Coincident indexes are designed to
are designed to help figure out the current state of the economy - Leading indicators are designed to help predict peaks and troughs - The first index was developed by Mitchell and Burns of the NBER in the 1930s
Pro or countercyclical 1. unemployment 2. consumption expenditure 3. inflation 4. nominal interest rates
countercyclical pro pro pro
Acid rain causes depreciation rate to rise permanently and causes according to solow model steady state capital ratio output per worker consumption per worker kong run growth rate of capital stock to
decrease decrease decrease does not change
An increase in the interest rate or return on nonmonetary assets _________ the demand for money - An increase in the interest rate on money ________ money demand - This occurs as people trade off liquidity for return
decrease increase
When looking at equilibrium equation for asset market M/P = L ( Y , r + pie^e ) A decrease in inflation expectations(pie^e), with no change in output, real interest rate, or the money supply, will result in ________ in the price level. An increase in the nominal money supply (M), with no change in output, real interest rate, or inflation expectations, will result in __________ in the price level. A decrease in output (Y), with no change in the money supply, real interest rate, or inflation expectations, will result in _________ in the price level.
decrease increase increase
If recession is approaching production will ________ investment average labor productivity real wage unemployment rate
decrease, decrease, decrease, decrease increase
An increase in the interest rate or return on nonmonetary assets ________ the demand for money - An increase in the interest rate on money ________ money demand
decreases increases
labor productivity growth _____ TFP growth because of ______ growth of capital relative to growth of labor
exceeds, faster
Which policy would decrease national saving? exchanging sales taxes for higher taxes on interest and dividends replacing income taxation with consumption-based taxation increasing allowable contributions to tax-free retirement accounts reducing deficit spending
exchanging sales taxes for higher taxes on interest and dividends
If all money was held in the form of currency, what would happen if the Federal Reserve bought financial assets (such as government bonds) from the public? The money supply would . If all money was held in the form of currency, what would happen if the Federal Reserve sold financial assets (such as government bonds) to the public? The money supply would
increase decrease
Gov policies to raise long run living standards
increase saving raise rate of productivity
Which of the following is a policy with a reasonable chance of increasing productivity growth? increasing population increasing taxes on investment income increasing the labor force increasing the number of grants for scientific research
increasing the number of grants for scientific research
- The break-even inflation rate:
interest rate on nominal bonds minus real interest rate on TIPS bonds • The break-even inflation rate is a rough measure of expected inflation • TIPS bonds have lower inflation risk, so the break-even inflation rate may be too high • TIPS bonds do not have as liquid of a market, so the breakeven inflation rate may be too low • The net effect of the two effects is likely to be small, so the break-even inflation rate may be about right
According to the expectations theory of the term structure of interest rates
investors compare bonds with different times to maturity and choose the ones that yield the highest return.
The key factor in economic growth
is productivity improvement • Productivity improvement raises output per worker for a given level of the capital-labor ratio
Define the velocity of money.
it is the ratio of nominal GDP to the amount of money in circulation.
• Durable goods production is _________ than nondurable goods and services • Investment spending is__________ than consumption
more volatile more volatile
Money demand _______ as real income rises
rises, because more income means more transactions - But money demand isn't proportional to real income, since higher-income individuals use money more efficiently, and since a country's financial sophistication grows as its income rises (use of credit and more sophisticated assets) - Result: Money demand rises less than 1-to-1 with a rise in real income
Why isn't the expectations theory sufficient to describe the data on interest rates that we observe?
on average, long-term interest rates exceed short-term interest rates
In total national saving formula in Solow model an increase in h causes what effect on on the steady-state value of per-worker capital? What is the effect on the steady-state value of per-worker output? What is the effect on the steady state of per-worker consumption?
per worker capital, output, and consumption decrease
The prisoner-of-war camp periodically received large shipments of cigarettes from the Red Cross or other sources. How did cigarette shipments affect the price level (the prices of goods in terms of cigarettes) in the POW camp? On some occasions the prisoners knew in advance when the cigarette shipments were to arrive. What happened to the demand for cigarette money and the price level in the camp in the days just before an anticipated shipment?
price level rose demand for money declines; the price level rises
What terms are used to describe the way a variable moves in terms of direction when economic activity is rising or falling? What terms are used to describe the timing of cyclical changes in economic variables?
procyclical and countercyclical leading, coincident, and lagging
Nominal money demand is _________ to the price level
proportional because higher price means more money needed for transactions
Classical economists think prices adjust _____ and that antirecessionary policies are _____, whereas Keynesian economists think the opposite.
rapidly, not neccesary
An increase in saving rate causes long run output, consumption, and capital per worker to
rise because higher savings allows for more investment and larger capital stock
What is the relationship between the equilibrium price level and the nominal money supply?
the equilibrium price level is proportional to the nominal money supply.
Price elasticity of money demand is_________, so money demand is proportional to the price level
unitary
Coincident, leading, and lagging variables
• Coincident: industrial production, consumption, business fixed investment, employment • Leading: residential investment, inventory investment, average labor productivity, money growth, stock prices • Lagging: inflation, nominal interest rates • Timing not designated: government purchases, real wage
- How does the central bank of a country increase the money supply?
• Could also buy newly issued government bonds directly from the government (i.e., the Treasury) - This is the same as the government financing its expenditures directly by printing money - This happens frequently in some countries (though is forbidden by law in the United States)
The M1 monetary aggregate
• Currency and traveler's checks held by the public • Transaction accounts on which checks may be drawn - All components of M1 are used in making payments, so M1 is the closest money measure to our theoretical description of money
Should a policy goal be to raise the saving rate?
• Not necessarily, since the cost is lower consumption in the short run • There is a trade-off between present and future consumption
- Income elasticity of money demand • - Price elasticity of money demand is unitary, so money demand is proportional to the price level
• Positive: Higher income increases money demand • Less than one: Higher income increases money demand less than proportionately • Goldfeld's results: income elasticity = 2/3
- How does the central bank of a country increase the money supply? reduce?
• Use newly printed money to buy financial assets from the public—an open-market purchase • To reduce the money supply, sell financial assets to the public to remove money from circulation—an open-market sale
