Macroeconomics

These are extreme positions. The Bank of Canada's actual path is somewhere in the middle. Some of the brunt of higher U.S. interest rates is taken in higher domestic rates, some through a lower valued Canadian dollar, and some through a loss of international reserves. List 3 extreme positions?

1. Increase in the interest rate as high as is needed to get sufficient capital inflow to prevent any fall in the Canadian dollar. 2. Let the Canadian dollar fall fully to its new lower equilibrium value. 3. Use our foreign exchange reserves to buy up as much of the excess supply of the Canadian dollar to prevent any fall in its value.

What is excess aggregate demand?

Aggregate demand exceeds national income/output. Output produced by the economy is not enough to satisfy all the aggregate demand, so firms producing and selling goods should experience a fall in inventories, a loss in sales from lack of inventories, or an increase in backlogged orders.

In which category or categories of the national expenditure account C, I, G, or X would spendings on commercial and residential construction, and a fall in inventories be recorded?

All 3 would be recorded in the investment category.

"Most economists these days are preaching that consumers had better start spending. Fears of unemployment have curtailed (decreased) consumer spending and starved the federal government of tax revenues needed to reduce the deficit." Does the fact that unemployment fears curtail consumer spending serve to stabilize or destabilize the economy?

Destabilize because the lower consumer spending makes unemployment worse.

"But in a loose sense, we are all Keynesians now - all of us, at any rate, who reject the notion that a sick economy heals itself by "natural" recuperative powers, without government action." This suggests that faced with a sick economy Keynesians would recommend...

Either or both of a stimulating fiscal policy and or a stimulating monetary policy.

What are excess cash reserves?

Excess cash reserves are reserves in excess of those they are legally required to hold or set by the banks in Canada. Excess reserves are the stuff from which banks create loans because banks can only make loans if they have excess reserves.

Explain how budget deficits could spur consumption and encourage investment?

Expansionary fiscal policy will increase AD and through the multiplier process stimulate the economy. The increase in AD causes GDP to rise. A larger GDP requires more capital equipment and will encourage investment in business plant and equipment.

What terminology would most economics use to describe quantitative easing?

Expansionary monetary policy - an expansion of the open market operations (purchase of bonds) of the central bank.

X is?

Exports: demand by foreigners for goods we send abroad like wheat and lumber.

At the moment the market is completely ignoring things like record U.S. trade deficits and the widening current account deficit. It is also largely ignoring the possibility of Federal Reserve rate cuts. Traders and investors are instead focusing on the fiscal easing in Japan. Why?

Fiscal easing in Japan will prevent the U.S. dollar from falling because it will increase income in Japan which will increase imports from the U.S. which will cause the U.S. dollar to rise.

Unemployment arising from these 3 sources creates the NRU, the natural rate of unemployment or "full employment." What are these 3 sources? Zero unemployment is not realistic, for several reasons - these are the 3 reasons.

Frictional unemployment, structural unemployment, and the institutional phenomena.

"The oil crisis caused U.S. oil companies overseas profits to shoot up, producing a jump in ___________ that could mislead policy-makers."

GNP

G is?

Government demand: demand by the government for hospitals, accountants, and armies.

What are automatic stabilizers?

Government policies that serve to reduce the multiplier without any need for time-consuming legislative action. Examples are government transfer payment programs like EI and welfare.

What is GDP?

Gross domestic product. Represents the goods and services that are produced during a particular period of time.

"The report attributed the strength of the recovery during the first three months of this year to increased consumer spending and residential construction, as well as a reduced rate of inventory liquidation." A reduced rate of inventory liquidation contributes to the recovery because it is caused by?

Higher aggregate supply which increases income and causes multiplier effects.

"Under present circumstances there is such thing as a "free lunch. In effect, all of the ingredients of that lunch are already there - the people who want to work, the factories and equipment standing idle, and the raw materials not being used. it is just a question of injecting a little spending power to prevent the free lunch from going to waste." What would happen if this policy of injecting a little spending power were undertaken without the ingredients listed above?

Higher inflation.

"Experts keen on the concept of Green GDP have offered a variety of suggestions to make economic statistics more environmentally friendly." Provide one example of this?

Ignore the cost of cleaning up after an oil spill.

Demand in each sector (C, I, G, X) includes demand for imported as well as domestic goods and services. To obtain what is important for the Keynesian view, aggregate demand for domestically produced goods and services, ____________ must be subtracted from the sum of C, I, G, and X.

Imports.

Explain what will happen to the Canadian exchange rate compared to the foreign exchange rate when the world demand for lumber, wheat, and paper increases. Ignore interactions with other sectors.

Increase in world demand for Canadian exports means an increase in world demand for Canadian currency. This results in an increase in the value of the Canadian dollar - as the demand goes up so does the value. This rise shifts DD to DD1 causing excess demand of Q5 to Qe; pushing the market from A to B. With SS representing the supply of the Canadian dollar and DD representing the demand for the Canadian dollar.

What do Keynesians recommend for artificial stimulation of demand?

Increased government spending and lower tax rates - the ensuing multiplier process will increase employment and income and therefor consumption demand further. This is also referred to as expansionary fiscal policy.

What is "expansionary fiscal policy"?

Increased government spending and or decreased taxes.

Explain why increasing saving is good in the long-run?

Increasing saving in the long-term will enhance growth and productivity - higher saving promotes higher investment. This increases capital stock, hastens the replacement of obsolete capital stock with modern stock, and raises the rate at which research and development produces new inventions., all contributing to a raise in productivity. This raise in productivity will ultimately increase living standards in the long-run.

The conventional wisdom has been that inflation's bad for the economy. If our inflation is running higher than our trading partners inflation, according to this argument, our growth slows and jobs are lost. Explain how the mechanism described here works?

Inflation is a determining factor in the value of money. If inflation is high than the value of money is low. If our inflation is running higher than our trading partners, companies will have to spend more money to purchase and produce the same goods and services that they did before. Output will decrease. Growth will slow and jobs will be lost because workers will no longer be needed. In addition, under a fixed exchange rate the domestic money supply falls causing the interest rate to rise and further reduce AD creating more unemployment. This problem could be avoided without curbing inflation by switching to a flexible exchange rate and letting the exchange rate fall annually by the difference in inflation.

What is meant by domestic costs remaining in line with foreign costs?

Inflation rates are the same.

I is?

Investment demand: demand by business firms for things such as factories, machinery, and delivery trucks.

Almost all of the fourth quarter increase in GDP wound up as unsold inventory sitting on the shelves." If it doesn't get sold, how could it get counted into GDP?

It is added when measuring GDP, as an element of investment demand (change in inventories).

"Economists expect to see some further liquidation of inventories this quarter, but at a slower rate. And that change from rapid to slow - from negative to less negative - shows up as a plus for the economy." This is a plus for the economy because?

It means that output is increasing.

Why would letting inflation get away for only a while require a painful return?

Letting inflation get away for only a while would require a recession caused by higher monetary policies, higher interest rates, and a slowdown in economic growth. It takes a very long time to lower inflation expectations. Inflation expectations rise quickly but fall very slowly.

"But as consumer spending slackened, stocks began to pile up. So an inventory correction is underway, and it will reduce this quarter's real GDP by more than 10 percent at an annual rate." This inventory correction will come about because of?

Lower output causing inventories to fall to what firms desire.

What is MPC?

Marginal propensity to consume: tells us what fraction of an additional dollar of disposable income will be spent on consumption.

What is MPS?

Marginal propensity to save: the fraction not spent on consumption.

What is the institutional phenomena (relating to unemployment)?

Minimum wage laws may make it too costly to hire extra labor, or generous unemployment benefits may make it easier to stay or become unemployed, or government regulations such as restrictions on how many hours per day a store can be open may decrease job availability, and or there may be racial or gender discrimination.

At the moment the market is completely ignoring things like record U.S. trade deficits and the widening current account deficit. It is also largely ignoring the possibility of Federal Reserve rate cuts. Traders and investors are instead focusing on the monetary easing in Germany. Why?

Monetary easing in Germany will lower the interest rate in Germany causing capital outflow to the U.S. and increase the value of the U.S. dollar.

What is equilibrium?

Natural forces cause our output of goods and services (aggregate supply and national income) to match the level of aggregate demand for our goods and services.

If it were a "stimulative deficit" that was deliberately undertaken to prime the pump of the economy, then the debt might liquidate itself. How would the debt liquidate itself?

Over time the debt could liquidate itself because of the boost in the economy. As more people begin working, incomes rise, causing tax revenue from both income and consumption taxes to increase. This is very unlikely however.

How does underestimation of the "true" rate of unemployment occur?

Part-time workers are counted as employed, even if they really want full-time work.

What are discouraged workers?

People without work who have looked long and hard for a job and have become convinced that there is no job out there for them. These discouraged workers are no longer counted as being in the labor force and so the measured unemployment rate falls.

An increase in government spending can be financed in three basic ways:

Raising taxes, selling bonds to the public, and selling bonds to the central bank (printing money). There are crowding out effects associated with all three of these ways.

Suppose the CPI is calculated assuming that one-quarter of expenses is for health, transportation, and entertainment, and three-quarters for all other items. When the price of items in the first category double and the prices of all other items quadruple, then?

The CPI overstates the change in the cost of living.

A growing number of economists view the Fed's new willingness to take on more of the nations debt as inflationary in the long run. Why?

The Fed can only purchase government debt by printing money which increases the money supply and causes inflation.

What does a "more hawkish view" of inflation mean?

The Fed took a more aggressive view of inflation - higher interest rates, and a reduction in the money supply - reducing AD so that inflation is reduced.

What is "the" multiplier?

The increase in equilibrium income due to a dollar increase in government spending.

"And so we find ourselves in the strange situation in which employment is rising and at the same time unemployment is rising." This could happen because?

The labor force is increased by more than employment.

Explain what a minimum cash reserve requirement is?

The minimum fraction of the total deposits from customers which banks have to hold as reserves with the central bank or in bank vaults. Legally required in the U.S., but not in Canada.

What would happen to wages paid for unattractive / unstable / seasonal job positions if unemployment insurance ceased to exist?

The number of these positions will fall. Because supply of the workers to these jobs will fall. This bids up the wage rate.

What are encouraged workers?

When the economy recovers from a recession, discouraged workers notice that times are better and that acquaintances have obtained jobs, encouraging them one again to look for work.

What would happen if domestic costs exceeded foreign costs?

With a fixed exchange rate the domestic money supply falls until inflation rates are equal.

Does the creation of part-time jobs affect unemployment in the same way as the creation of full-time jobs?

Yes. Part-time workers are counted as employed, even if they really want full-time work. This means that a part-time job and a full-time job have the same effect on the unemployment rate.

An increase in the number of discouraged workers will:

decrease the measured level of unemployment.

Other things equal, an increase in the number of discouraged workers will:

decrease the size of the labour force.

Republicans are already eyeing changes to the inflation measure as a way to meet their goal os halving the budget deficit by 2002. The CPI is used to adjust social security and other benefits, and income-tax brackets, for inflation." The suggested changes will lower the deficit because measured inflation will be...

decreased which decreases social security payments.

Consumption is a function of after-tax or _____________ income.

disposable

Because pollution is a by-product of many production processes, GDP accountants should adjust GDP ____________ but do not, causing GDP to _____________ economic welfare.

downwards; overstate

Financing by printing money mixes _______ policy of increased government spending with a ____________ policy of increasing the money supply.

fiscal; monetary

An example of bias in the CPI measure is that it...?

ignores most quality changes.

But economists believe that one of the most important sources of bias in the CPI as a measure of the cost of living is when consumers shift their buying patterns in response to changing relative prices, buying...

more of relatively cheaper things and less of relatively more expensive things.

This is the heart of the Keynesian analysis: aggregate demand is the driving force that determines the level of _____________.

national income.

A reduction of inventory is entered as a __________ ____________ in the national accounts.

negative investment

"Even if employment continues to climb, the jobless rate will likely stay around its current level for the balance of this year. Thats because ______________"

of increases in the participation rate.

"Note that the percent change in the GDP deflator is being used as the measure of inflation rather than the more familiar CPI. The GDP deflator is a price index that samples _________, not just those paid by consumers."

prices of all domestically-produced goods and services

An increase in the number of encouraged workers:

raises the unemployment rate and the participation rate.

"The government insists that the CPI measures consumer prices, not the cost of living. But don't shoot the CPI - whether bringing good news or bad, its the best messenger we've got." During a typical inflation...

the CPI rises by more than the cost of living.

Budget deficit are sometimes useful to spur consumption and thus encourage investment in business plant and equipment, but more generally they discourage rather than encourage because...

they raise interest rates.

Goods and services are valued at market prices when calculating GDP. Because the "outputs" of government are not sold, they have no market prices. In the actual calculation of GDP they are...?

valued at the cost of producing them.

What is an overshoot?

An overshoot is the difference between the actual exchange rate and the new equilibrium exchange rate. An overshoot in the exchange rate means that it changes more than is required to move to a new equilibrium value. Changes in the equilibrium value of the exchange rates are caused by shifts in demand or supply - changes in exports, imports, interest rates, travel, capital flows etc.

Why would commercial banks be sitting tight since the 2007 crisis?

Banks were not eager to lend after the subprime mortgage crisis. Many of the subprime mortgages had defaulted and the banks had low confidence that borrowers would be able to pay loans back.

Explain why M2 velocity should be more predicable than M1 velocity?

Because shifts in and out of M1 demand deposits into M2 savings deposits increase the interest earned on bank deposits, which changes the value of M1 but not the value of M2 - this is because M2 includes both M1 and interest earning deposits.

Hows does stepping up the rate of creation of the money supply reduce interest rates?

Buying bonds injects excess reserves into the banks. The banks must lower the cost of borrowing to attract additional borrowers.

The new nations GDP figures (updating the base year) will account for changes in consumers tastes, technological advances, and other phenomena. How will this accounting be done?

By re-evalutating the CPI typical bundle. CPI is a weighted average of all consumer prices, with the weights given by the relative importance of different goods and services. The CPI is calculated by the Bureau of Labor Statistics by observing changes in the cost of goods and services. The typical bundle is updated every 2 years (in the even numbered years).

C is?

Consumption demand: toys and haircuts.

Explain a form of intervention used to counteract a specific overshoot?

Currency intervention, also known as foreign exchange intervention. The central bank monitors changes in the exchange rate. To prevent overshoot it buys or sells the currency as needed. This will remove the imperfection of the market which causes the rate to overshoot its new equilibrium value thereby stabilizing changes in the rate. The rate will still rise and fall but no more than required.

What is structural unemployment?

People who are unemployed because technological progress has made their skills obsolete or new trade agreements have changed the nature of what is produced domestically.

How will a U.S. tax cut and increased U.S. defence spending influence the U.S. economy?

Expansionary fiscal policy. An increase in aggregate demand, created by a stimulating dose of fiscal policy causes producers to increase output and restore fallen inventories. The resulting increase in income leads to an increase in consumption demand, extending the expansion. This is the essence of the multiplier process, where an increase in government spending or a tax cut leads to a much larger increase in income.

"Suppose that a new computer is invented that costs one-quarter of existing computers and performs as well. Now when GDP is calculated production of the same number of computers created only one-quarter as much dollar output - GDP falls! (T/F)

FALSE - real GDP should be unchanged because of price index adjustments.

Why would encouraging saving during a time of recession be risky?

It will strain an already struggling economy. An increase in savings means a decrease in consumption. AD will reduce and stall recovery.

What is M2 velocity?

M2 velocity is the ratio of nominal GDP to the total value of the M2 money supply.

Money deposited for a term is not left in the bank vault but is loaned out by the banks (subject to minimum cash reserve requirements). this means that a dollar on deposit can flow back into the banking system one or more times and that dollar can expand the money supply. What is this process referred to as?

Money multiplier in a fractional reserve banking system.

Does a fall in inventories appear in the national expenditure account as a positive or negative number? Why?

Negative. GDP measures only this years output. More output was sold than was produced this year. Some of last years GDP was sold this year.

How does overestimation of the "true" rate of unemployment occur?

People not wanting work pretend to want work in order to collect unemployment benefits, or the unemployed are not willing to take a job unless it pays an unrealistically high wage rate, or when those measured as unemployed are actually "employed" in the underground economy.

What is frictional unemployment?

People who are temporarily unemployed because they are in the midst of changing jobs or looking for an initial job, the ongoing process of improving the occupational and geographical match of workers and jobs.

Three main ways for profit maximizing firms to react to excess aggregate demand?

Quantity adjusters: increase output to meet the higher level of aggregate demand by using existing employees and equipment more productively, by hiring additional workers, or by increasing work hours. Price adjusters: increase prices to induce people to decrease aggregate demand to the level of output that is being produced. Both: they could adopt some combination of both ways.

Last year Argentina experienced robust growth and fiscal restraint, but some analysts continue to worry about its current account deficit, which today is 4 percent of GDP But this worry is wrongheaded because this deficit is the result of the confidence of foreign investors in Argentinas new economic system. How could this deficit be the result of the confidence of foreign investors in Argentina?

Robust growth in Argentina attracts foreign business investment in the Argentine economy. But to invest in Argentina the foreign firms must buy the Argentine currency. This bids up the Argentine exchange rate which reduces exports and increases imports causing a trade deficit. A trade deficit is also a deficit in the current account.

A trade deficit, he said, is not an indication that a country has low productivity or low-quality products. It is an indication that the domestic investment rate is high relative to the rate of _____________.

Savings. The funds for investment comes from savings. If a country savings is zero it must lend and invest zero. But a country can get funds from foreign countries. Therefore if domestic investment exceeds domestic savings there must be an inflow of foreign funds. For those foreign funds to enter the foreigners must buy the country currency. This pushes up its exchange rate which lowers exports and increases imports causing a trade deficit.

How could artificial stimulation of demand trigger runaway inflation?

Stimulating the economy this way could trigger runaway inflation in the increased AD exceeds full employment GDP and the central bank accommodates the resulting inflation by increasing the money supply.

The principal power of the central bank to lower interest rates lies in its ability to contribute to a lower rate of inflation, and that takes time. How would the central bank contribute to a lower rate of inflation?

The Fed decreases the money supply by selling bonds. This decreases the price of bonds which increases the interest rate. In addition, selling bonds reduces the excess reserves of the banks. The banks will increase the cost of borrowing and discourage additional borrowers. Less borrowing reduces inflation by reducing AD.

What is a balanced budget multiplier?

When the increase in government spending is financed by raising taxes (crowding out). If taxes are raised to finance an increase in government spending, disposable income falls and so consumers reduce consumption. The decrease in consumption demand partially offsets the increase in government spending, reducing the size of the multiplier.

How could a deficit "prime the pump" of the economy?

The Keynesian view is that increased government spending and lower tax rates and the ensuing multiplier process will increase employment and income. This is referred to as expansionary fiscal policy.

Define the unemployment rate? Formula definition.

The number of unemployed people who want to have a job but do not have one, expressed as a percentage of the labor force (the total number of people aged 16 and over who want to have a job).

Define the participation rate? Formula definition.

The percentage of the civilian non-institutional population aged 16 and over in the labour force.

What is the multiplier process?

The process whereby an increase in government spending leads to an extended increase in income.

What people are considered to be unemployed?

The unemployed are people who want a job but don't have one - they are the people actively looking for work.

How does the central bank manage excess reserves?

Through open market operations which is the buying and selling of government bonds. The central bank buys bonds from the banks to increase their excess reserves and sells bonds to the banks to reduce their excess reserves.

What is cyclical unemployment?

Unemployment above the NRU; it is often used to measure the cost to the society of unemployment (loosely speaking we could consider the economy to be in recession whenever the unemployment rate is above the NRU and in a boom when the unemployment rate is below the NRU).

"Manufacturers ended last year on a strong note with both shipments and orders rising to record levels in December. At the same time there was an ominous (concerning) buildup of inventories, which also rose to a record level." The buildup of inventories is ominous because it suggests that?

Unemployment will develop.

What is a "dangerous imbalance" phenomenon relating to GDP?

Unsold inventory implies that producers over-estimated AD. With AD<GDP firms will reduce output and employment.

If inventory doesn't get sold, how could it get counted into GDP?

Unsold inventory is a measure of GDP at the time of its production, not at the time of sale.

The introduction of daily interest saving accounts attracted a growing portion of funds away from checking accounts. The upshot was that a given amount of M1 supported a higher level of total spending, or in other words, its ______________ increased.

Velocity.

What are the long-run implications of the middle-of-the-road policy?

We will eventually use up all of our foreign exchange reserves.

The rise of the dollar could better the profits of some U.S. companies this year and slice into capital spending. Which companies may have their profits battered?

When the value of the dollar rises, imports rise and exports fall affecting export companies and companies producing goods which compete with imports negatively. Battered companies have less funds and incentive to invest - so this slices into capital spending.