Short Answer_ EGB Exam 2

6. If banks decide to hold some of their excess reserves instead of lending them all out, then:

a) the money multiplier will be less than 1 divided by the required reserve ratio.

5. If the marginal propensity to save decreases from 0.6 to 0.5

a) the slope of the consumption function increases from 0.4 to 0.5

3. Joe recently completed his college degree and is entering the labor market for the first time as a plumber. He has been submitting applications and has been interviewed twice in the last two weeks, but so far has not found a job (should have gone to Stern). Joe would be classified as:

a. Frictionally unemployed

5. For which of the following goods is demand most sensitive to interest rate changes?

a. Refrigerators: Recall durable goods discussions in class.

1. If the Fed conducts an open market purchase of bonds, which of the following will happen?

a. The interest rate will decrease, the aggregate expenditure line will shift upward and the aggregate demand curve will shift rightward

3. Assume an economy that is contracting and unemployment is rising. Which of the following would be a logical explanation for a sudden fall in the unemployment rate even while the economy continues to contract?

b) an increase in the number of discouraged workers

1. When actual output is above potential output:

b) nominal wages will increase, and the short-run supply curve will shift to the left.

5. Stabilization policies have:

b) reduced the economic fluctuations caused by demand shocks but have not been effective against supply shocks.

3. The higher the current production capacity of the economy

b) the lower is investment spending

9. The effective demand deposit multiplier is likely to be smaller (e.g. banks are less likely to lend even when reserves are injected into them by the fed):

b. During periods of recession

6. If the actual interest rate is above the equilibrium interest rate, the

b. Price of bonds will increase

8. In 2008, consumption spending is $7,000, government purchases is $2,000 and investment spending is $1,500. If GDP for 2008 is $10,300, then:

c) export is $600 and import is $800.

5. Which of the following would an economic policy maker rank as the most preferred type of shock?

c) positive supply shock

1. An example of a capital good

c. A house owned and occupied by a family

6. Which of the following can lead to stagflation?

c. A prolonged increase in oil prices

5. Which of the following would lead to a rightward movement along the aggregate expenditure line rather than a shift in the line itself?

c. An increase in income of $50 billion

1. Increases in investment spending cause interest rates to increase. As a result,

c. Households will voluntarily decrease their consumption spending

2. GDP as predicted by the classical, long-run model is

c. Smoother and steadier than actual GDP

2. Dennis is an excellent typist. However, because he has been unable to adapt to his company's new computer system, he has lost his job. He is currently seeking another secretarial position, but it is likely that he will have to acquire new skills to become employable as a secretary again. Dennis would best be described as:

c. Structurally unemployed

1. Some of the inaccuracies in measuring GDP are attributable to

c. the underground economy and quality changes

3. National savings in a closed economy is all of the following except:

d) Government spending less consumption

4. Which of the following is the most accurate statement concerning the relationship between government budget deficits and economic growth?

d) We can not say unambiguously whether government spending that increases deficits lowers or increases economic growth.

7. Suppose that a country has a progressive income tax code, where taxable income is calculated in nominal terms but the schedule of income tax rates is NOT indexed to inflation. An individual whose income keeps up with inflation will find that, overtime, she will pay:

d) a higher percentage of her income in taxes over time. WE DIDN'T GRADE THIS AS IT WAS TOO ABSTRACT

2. If Congress places a $5 tax on each ATM transaction, there will likely be:

d) a shift to the right of the real demand for money curve.

2. Government spending is like investment for all of the following examples except when:

d) it is used for a personal income tax rebate

2. A fall in the market interest rate makes any investment project:

d) more profitable regardless of whether the funds were borrowed or came from retained earnings.

2. In the short run, a decrease in government purchases would

d. Decrease real GDP because of the multiplier effect, but be somewhat offset but the decreases in the price level and interest rate

2. Assume net exports are -$220, consumption is $5,000, tax revenues are $1,000, government purchases are $1,500, and 2003 GDP, calculated by the expenditure approach, is $8,000. We can conclude that

d. Private investment was $1,720

1. According to McKinsey and Company, a famous business consulting firm, which sector is responsible for most of the growth that took place in the United States during the 1990s?

e) The retail sector

10. If the economy is on the aggregate supply curve but to the right of the aggregate demand curve, which of the following will be the first market force to lead the economy toward an equilibrium?

e. At the current price level, output will be too high and firms will cut back on their production.

3. The Consumer Price Index (CPI)

e. Includes the prices of some used consumer goods

3. Which of the following would not increase autonomous consumption spending?

e. Increased disposable income

4. Suppose there are no firms, only the government and households. What would the result if for some reason the supply of savings at every interest rate suddenly fell?

e. Interest rates would rise and the levels of savings would not change.

1. If labor supply and labor demand both increase, employment

e. Will increase but the effect of the real wage rate cannot be determined without more information

If in an open economy, a country imports more than it exports and the government budget deficit increases

the change in interest rates is ambiguous, but the amount of borrowing will increase

We often mention multiplier in class of 2.5 (or more) for the US using our standard multiplier formula used in our calculations. But in the real world are estimates are lower. Why? Name two factors making the multiplier smaller than is captured in this formula

-Imports/Leakages -Taxes (automatic stabilizers if taxes are mentioned) -Takes time for money to move around/move from agent to agent. -Banks hold onto excess reserves (not really answering this, but will accept

Who gets hurt by unanticipated inflation? Who gets helped by anticipated inflation?

-Lenders are hurt by unanticipated inflation. -No one is helped by anticipated inflation.

What is subprime lending and how has that been a recent problem?

-Lending to people with poor credit histories/without proper down payments 1.5 pts -Led to/contributed to credit crisis. 1.5 pts.

7. If the Fed conducts an open market sale of bonds, which of the following will happen?

-The interest rate will increase, -The aggregate expenditure line will decrease -aggregate demand curve will shift leftward

What is a balance sheet effect

-The reduction in a firm's net worth due to falling asset prices or -sudden sale of assets by one firm, reduces prices, creating problems for other firms (Contagion)

Why has crowding out not been a bigger issue in the US in recent years given deficits

-We have been able to borrow from other countries -trade deficit -capital inflows

Do airlines (like United Airlines) fair better or do they fair worse than most industries in a recession and why?

-Worse -High fixed cost industry

What are two ways that a change in wealth can affect the AD curve

1) Can move the AD curve to the right. AND 2) Can also be movement along the curve

3. What factor(s) cause a movement along the money demand curve? What factor(s) will lead to a shift in the money demand curve (left or right)?

A change in the interest rate causes movement along the money demand curve.

Which of the following can lead to increasing GDP and decreasing price level

A steep fall in nominal wages

2. What factor(s) cause a movement along the AS curve? What factor(s) will lead to a shift in the AS curve (up or down)?

Any change in REAL GDP that causes a change in the price level leads to movement along the AS curve. (Key is that it comes from change in GDP).

What is an automatic stabilizer? Give an example.

Any time government spending automatically increases due to a recession (or an expansion) without any needed change in policy. For example, as economy expands taxes increase. Some unemployment insurance is an automatic stabilizer (as more people lose jobs, spending on unemployment goes up). Medicaid and Food stamps are also good examples.

The book mentions several proposals to reduce carbon emissions (for example Lieberman-McCain and Sanders-Boxer proposals). By approximately/roughly, what percent would either of these proposals if enacted reduce GDP

Any value < 5%

Please describe one benefit and one risk of fiat money?

Benefits: 1. Low cost to produce. 2. Supply can be adjusted based on needs of economy Risks: 1. Counterfeiting 2. Government's may use printing press to pay bills 3. Inflation

1. Why has the current administration turned to fiscal policy? What problem is there currently with relying on monetary policy to get us out of the current recession?

Both questions are answered by the fact that with interest rates at or close to zero, monetary policy is losing its effectiveness. Or a student could allude to this condition by just mentioning a Keynesian liquidity trap.

What is inflation targeting? What is a criticism of it?

Central Bank announces a specific target rate for inflation (for example 2%). Critics suggest there are times of crisis when other factors are more important than just inflation.

8. Why has the discount rate historically been a less popular tool for the Fed to use than the Federal Funds rate?

Correct answers may state that banks did not want to borrow as they would be put under Fed scrutiny/review. Or they may state that banks feared borrowing from the fed using the discount rate would signal to the Fed or other banks that they were in trouble.

Assume the stock market doubles in value this year. Would this impact aggregate supply, aggregate demand or neither?

DEMAND

When wealth increases, does the money demand or supply curve shift? In which direction?

Demand Right

Why would we expect the fiscal multiplier to be lower when unemployment is very low?

Economy operating at "full capacity" or "without slack" or words to that effect were fine for ius

What is the Federal Reserves Dual Mandate? Under what circumstances would the fed have trouble following both parts of the mandate

Fight inflation and unemployment (aka full employment/natural unemployment and stable prices). Stagflation or a negative supply shock.

What is underemployment?

Forced to work part time but want full time position

Who (group, entity or assortment of people, etc.) holds most of the actual US currency in circulation?

Foreigners

Between which of the following pairings of economies would you expect to see convergence?

France and Germany

Where does the convergence hypothesis appear to have held? Where does it not appear to have held? Where is has not, why hasn't it?

Holds among wealthy countries. (1pt) Does not hold among poor countries. (1pt) Factors like education, infrastructure, rule of low or similar factors prevent it being held (1pt)

What was Paul Romer's New Growth Theory

Idea that technological progress/productivity does not just happen (it is not exogenous), but comes from polices, incentives (it is endogenous).

If the CPI underestimates inflation, what group in the US is a major loser from government policies?

If they put retirees or people receiving social security full credit. If you put lenders of money also okay.

1. What are shoe leather costs and does the US face them?

Increase in costs due to inflation (not necessary for full credit but literally people have to run around a lot from banks to stores). -US does not face them

What is the ISM and what does it produce/report

Institute of Supply Management or organization that produces estimates of GDP/business production/statistics

6. Assume there are no savers in the economy. The government runs a surplus. Assume the government increases its surplus this year. What will happen to the interest rate and quantity of funds for investment supplied in the economy?

Interest rate goes down and quantity of funds increases.

Thinking about the market for loanable funds, presume a country has a budget surplus and it is a closed economy. If the government budget surplus decreases and at the same business becomes more pessimistic about the future what will happen:

Interest rates will___Change is Ambiguous Amount of borrowing will___Decrease

Why is discretionary fiscal policy less important in a country like Germany when it goes into a recession?

It has large automatic stabilizers and so doesn't need discretionary policy

A shift away from taxing asset income toward taxing consumption would lead to

LOWER_interest rates HIGHER_economic growth

What did Franklin D. Roosevelt's budget director argue would be the end of Western Civilization?

Leaving the gold standard/Fiat Currency

When a waiter deposits his cash tips in his savings account:

M1 immediately decreases

1. What is monetary neutrality and does the international evidence suggests it holds or not?

Monetary neutrality holds that the supply of money/inflation has no effect on potential output in the long run. Evidence suggests it does hold

For each of the following, would it make the fiscal multiplier larger?

More imports___No High Unemployment__Yes/Check High Taxes___No Tax cut is targeted to wealthy__No Tax cut is targeted to poor___Yes/Check Government spending is targeted toward construction/public works___Yes/Check Public concerns that taxes will be higher in future years to finance current spending ___No

Does the textbook believe that Ricardian equivalence is a problem for government policies to manage the business cycle

NO

What would be the impact on the US economy of the discovery of a new fertilizer that increased the yields of all the major food crops grown in the country

Price Level____Decrease GDP_______Increase________________

Oil prices are collapsing lately (from $105 this summer to $80 today). Presume this sharp decline in oil prices persist over time. What would be the impact of this on the US economy in the short run (increase, decrease, unchanged)?

Price level____Decrease GDP___Increase Unemployment______Decrease

Can you give an example of unit of accounts costs

Problems of doing contracts, of measuring prices, affect on taxes

Why does the United States have a lower savings rate than most other wealthy countries? Offer two arguments from the book.

Strong system of financial intermediation Strong government retirement system (social security)

According to the NY Times article "Job Report Highlights...", declining unemployment (increasing employment) has not lead to significant wage growth in the last 5 years

TRUE

We have an economy with a trade surplus. If the trade surplus gets larger, the supply of loanable funds gets smaller

TRUE A trade surplus is a capital inflow

What is the Walmart effect/big box boom

The fact that Walmart and other big box stores were important drivers of productivity." Or "Everyday small improvements drove productivity improvements" Or words to that effect

3. What was the information technology paradox?

The fact that the information technology revolution did not (at least did not until recently) lead to increases in productivity. Any answer that talks about the lack of productivity is fine.

What is Ricardian equivalence

The notion that any increase in a budget deficit will lead to a decrease in spending

According to the article "Aggressive ECB Stimulus Ushers in New Era for Europe", what does Europe need to do to recover from the financial crisis? (Hint: It's not quantitative easing.)

They need to reform their economies/engage in structural reform.

One of the lags associated with fiscal policy is the time it takes to recognize that the economy has developed a recessionary or inflationary gap

True

When the stock of physical capital of US firm is low, Aggregate Demand will increase

True

Who has had higher productivity growth since 2000? Europe or US?

US

2. What is debt deflation and how can it make depressions hard to escape?

Under deflation, debts become more expensive to repay as prices fall (e.g. wages, profits) but the debt fixed. This means firms and individuals are reluctant to borrow money (take out loans) and so it is very hard to escape the depression.

Give an example of a labor market institution that affects the natural rate of unemployment.

Unions, Minimum wage, any possible rule or organization affecting employment was great

Are used goods and imports part of GDP? Part of CPI?

Used Goods in GDP: No Imports in GDP: No Used Goods in CPI: Yes Imports in CPI: Yes

3. What are efficiency wages?

Wages given to workers as an incentive to be more productive. (Not necessary for full credit: but this can distort the labor market, lead to structural unemployment.)

Is stabilization policy stabilizing (in other words, has it worked according to the textbook)

YES

Inflation is bad as it enriches banks by taking away from the people and destroying the middle class(e.g. borrowers

False bc Inflation saves borrowers money and costs lenders

Other than the US, name a country that suffered a banking crisis according to the book

Finland, Sweden, Japan and Ireland

What did Kuznets develop that was called "one of the greatest inventions of the 20th century

National Income Accounts (system for tracking GDP, spending, etc.)

How do used goods affect GDP calculations? How do they affect CPI calculations?

Not in GDP. Used in CPI calculations

What is disinflation? What costs are associated with it?

Process of bringing down inflation. Cost is slowing down your economy or answer could mention recession or answer could mention unemployment

What is an advantage of the PPI over the CPI in trying to measure inflation trends

Responds to changes in prices more quickly" or "is an early warning signal

What was regulation Q

Rule prohibiting banks paying interest on deposits (anything mentioning interest by banks was accepted as this was a pretty hard question...)

2. What factor(s) cause a movement along the AD curve? What factor(s) will lead to a shift in the AD curve (left or right)?

-Changes in the price level cause a movement along the AD curve -Changes in a, Ip, G, NX, changes in net taxes, and changes in the money supply all lead to a shift in the AD curve itself

5. What are five of the functions of the Federal Reserve? (Just list them)

-Supervising and Regulating Banks -Acting as a Bank for Banks -Issuing Paper Currency -Check Clearing -Controlling the Money Supply

1. Under what circumstance might monetary policy fail to work?

-When interest rates approach zero. -When you are in a Keynesian liquidity trap -When the banking system is in turmoil (like now) and banks hold onto money as excess reserves

Cite one way the ECB differs from what its American equivalent. (Guess/Be creative if you are note sure.) What does ECB stand for?

1.5 pts. Could be lots of stuff (really this is a test if you know ECB) -Cares primarily about inflation and not unemployment / single vs. dual mandate -Comprises several countries. 1.5 pts = European Central Brank

What is a cyclically adjusted budget balance and how is the concept useful/important?

Adjusts the budget balance for macroeconomic conditions.. 1.5 pts. Useful/important (1.5 pts), Full credit if you: - explained how in a recession a budget deficit would be smaller than it appears as the deficit is only growing because tax receipts fall in recessions while spending increases (deficit is not due to a longer term imbalance between taxes and spending). - Full credit if you how this tells you how a concept allows you to treat these large deficit as less serious given they are only created due to recessions (assume you know sentence above and explains impact).

4. How is the Federal Reserve independent of the rest of the Federal Government (what aspects of its organization and decision making increase its independence from political pressures)? Why was it designed to be independent?

Answers should note that the members have long terms and can not be fired by the President. Decisions on interest rates are made by the FOMC, not just the board of governors and this includes members of the regional Fed banks as well (who are appointed by local banks and not the government).

What do we mean when we say the economy is at long-run macroeconomic equilibrium?

Could be answered a few ways - only need one answer and we accepted several, including: -AS = AD at LRAS -There is neither an inflationary or recessionary gap. -We are at zero cyclical unemployment

What does the book argue is the major advantage of a consumption tax over existing income taxes

Encourages savings/increases supply of loanable funds/leading to more investment

As exports increase, the income from those exports becomes available for domestic investment, increasing the supply of funds

False

If you had heard that in the market for loanable funds that the interest rate had fallen, equilibrium investment had increased and household savings had declined slightly, what else must have occurred

Government must be running a surplus. If we saw the world "surplus" chances are it is correct

What are any 4 government policies that a government can use to promote "Longterm" economic growth according to the textbook?

In terms of long-term economic growth, lots mentioned in the book (all are fine) -Government subsidies to the infrastructure -Government subsidies to education -Government subsidies to R&D -Creating or maintaining a well functioning financial system -Protecting property rights -Ensuring political stability and good governance Question is for long-term, but if we are talking short-term/Keynesian model, the policies would be (any of these count): -Cutting taxes -Increasing spending -Cutting interest rates

Why did the book argue was the major downside/problem with the Stability Pact?

It is pro-cyclical or the opposite of an automatic stabilizer. It forces states in recessions to cut spending, make recession worse

According to the textbook, does fiscal austerity work?

NO

What is the Solow Paradox? What are two explanations for it from the article "Technology isn't working"?

New technology/information technology has not lead to measured improvements in productivity (or students may say it occurred when productivity growth was slowing). 1pt. Any two of these explanations was great (1pts each). The article argues that: -IT isn't as impressive as it seems, can't offset demographic decline, inequality or sovereign debt (this is according to Gordon and probably wrong but mentioned) -There is a long time lag with productivity -Availability of cheap labor has slowed technological adoption

Do most economists believe budgets should always be balanced. Explain

No Any of these answers is fine for full credit for me. -Takes away ability to respond to a crisis or recession -Eliminates automatic stabilizers. -Ignores fact that tax receipts fall in recession -Ignores fact that government spending should rise in recession

How did the Federal Reserve balance sheet change after 2007? What is the most common type of security (asset) it normally trades with banks to influence interest rates

Part 1 - either grew in size or took on new types of assets (non traditional, etc.) Part 2 - US treasuries, US securities, US bonds. If your answer mentioned bonds or security and do not mention government we just took -1 off

What is the life cycle hypothesis of spending

People smooth their income over their lives.

Workers who would like to find full-time jobs but are currently working part time for economic reasons are called

Underemployed

2. As economy is contracting and unemployment is rising. You open the newspaper one day to see that the unemployment rate fell even though the contraction continues. What would be a logical explanation for the reported unemployment rate falling even though the economy continues to contract?

Unemployed people give up hope of finding work and leave the labor market (e.g. or they may write they become discouraged workers). Such workers are not counted as part of unemployment.

2. Suppose the population grows by 2 percent annually. For the standard of living to rise, which of the following MUST occur (hint: more than one could occur, but this one MUST be the case)?

b. Real GDP must grow by more than 2 percent

. Please offer three reasons why the natural rate of unemployment fell in the US since the 1970s

changes in experience of workers, decline of unions, temporary placement businesses, the internet use to find jobs, minimum wage laws, government job training, employment subsidies, other government policies

4. In the closed economy of Sildavia, government spending during 2005 was $30 billion, consumption was $70 billion, taxes were $20 billion, and GDP was $110 billion. If investment spending in Sildavia during 2005 was $10 billion, we can conclude that:

d) private savings were equal to $20 billion.