Macroeconomics for Global Decision Making
Please type all answers. Page numbers. Bibliography. No title page. You can have as many sources as you want. I put down a minimum of (6) sources however, that?s just a minimum. If you need to add more, please do so. Answer All Questions and Clearly Define Your Terms Place your answer to each question on a separate sheet of paper and type answers to all questions. Document your answers and show your work. Read each question carefully and answer all parts. The number in parentheses is the point weight for the question. Make sure you label your questions, ex. 1.) A:, 1.) D: ?. And so on. You may add another page for graphs or figures. Number each page and clearly indicate the question number.
(50) 1. (a) Aggregate Demand is defined as:
AD = C + I + G + NX
Where AD is aggregate demand, C is consumption expenditures, G is government (federal and state and local) expenditures, and NX is net exports (Exports ? Imports).
To encourage the growth of AD, fiscal policy can influence G through changes is expenditures, such as the fiscal stimulus of 2008 and 2009, and on C by changes in transfer payments such as Medicaid, Medicare, unemployment benefits and Social Security that change disposable income. If such changes take place, how are they transmitted to increase both GDP and employment? When are they least effective and most effective in changing GDP and Employment? Has the large fiscal stimulus in 2009 had the benefits that Congress and the Administration had anticipated?
(b) Suppose the Fed has already decided that it wants to target the money stock.
(1) Will the Fed come closer to its target by setting the interest rate at a given level, or will it do better by fixing the money supply through open market operations? In your analysis, think in terms of the Fed’s horizon from one Open Market Committee meeting to another — about 4-6 weeks. This analysis involves the relative stability of money demand and the money multiplier. Consider two alternative cases: (1) a stable demand for money allows the Fed to set an interest rate that ensures it will come close to the target money supply; and (2) an unstable demand for money.
(2) In your analysis, discuss the proposition that the Fed may need to target interest rates in the short run in order to meet its target money stock while in the long run it may need to pay attention to interest rates and bank reserves and currency growth. NOTE: Shifts in money demand may reveal themselves first in movements in interest rates — and if the Fed wants to stabilize the economy, it should respond to shifts in money demand.
(c) Within the same general context, discuss why the Fed, if it wants to stabilize and grow GDP and employment, has chosen a quantitative easing (QE) approach by growing bank reserves though purchases of Treasury securities and mortgage-backed securities and the monetary base rather than an interest rate policy (presently QE2 policy is to purchase $85 billion per month of Treasury and mortgage-backed securities? Why has the European Central Bank (EU) and Japan followed the same policy? How does this process work to stimulate economic growth? Has the QE policy since 2011 worked to increase GDP growth and employment?
(d) In the case of a liquidity trap, what is it that makes monetary policy ineffective in such a case? Recall that effective monetary policy requires that banks lend to willing borrowers. What does it mean for an effective monetary policy if the velocity of money declines substantially?
Velocity (V) = Price Level (P)*Real Output (Y) / Money Supply(M)
V = P*Y/M2
Or to look at it another way: P*Y = V*M2
So a change in M2 will lead to smaller changes in P*Y the smaller is V.
(50) 2. There are many views of the state of the global economy in the late Summer early Fall of 1998. Below are some of these views. From your reading of Commanding Heights (Yergin and Stanislaw), current news accounts, research into various economies and Macroeconomics (Dornbusch and Fischer), critically analyze these statements as to the type of policies that national economies and the IMF should pursue over the course of the next few years. Has the free market system of capitalism failed and the "battle between government and the marketplace that is remaking the modern world" (Yergin and Stanislaw) tilting toward government? Or, is there a middle ground that needs to be reached with a global regulatory structure created that makes countries and their financial systems more transparent and less tied to "crony capitalism"? Express your views, but back them up with fact and supporting argument.
The Economist (September 5, 1998) "The World Economy on the Edge: The risks of a deep global recession are increasing. But it can be avoided so long as policymakers heed some lessons from history."
The Economist (September 5, 1998) "The Economist all-items commodity-price index has fallen by 30 percent since mid-1997, to its lowest level in real terms for over 25 years. The prices of industrial commodities are now at their lowest in real terms since the 1930s. This has severely hurt commodity producers, not just in Latin America and Africa, but also in Australia and Canada." (add in the U.S. farmers).
The Economist (September 5, 1998) "Capitalism in retreat? A related and more worrying backlash against the free markets is the increasing interest on the part of politicians and economists in market intervention or capital controls as a solution to the crisis…..On September 1st, Malaysia imposed strict controls on capital movements. And respected American economists are also now arguing the virtues of capital controls. This, he (Paul Krugman) suggests, would break the link between domestic interest rates and exchange rates to get their economies growing again….Indeed, the biggest risk now to the world economy may lie not so much in a deep recession, which could be averted. It is that there may be a wholesale retreat for free markets."
Robert Kuttner (Washington Post, September 7, 1998, p. A25) "Free Markets and a Free Fall World Economy. Economic reconstruction after World War II accepted the necessity of a mixed economy. In that era, the United States and the International Monetary Fund recognized that emergent economies could no be the prisoners of private speculative capital. The postwar system regulated private money flows and stabilized currencies to allow nations to develop. Today’s IMF, perversely demands exposure to speculators as a precondition of assistance….What we need is a program of stabilization and reconstruction in the spirit of the post-World War II years, with limits on speculative money flows and more development aid."
Washington Post, December 22, 1997, p. A1) "IMF Credibility Is on the Line In Asia Bailout, Agency Should Rethink Rescues, Some Critics Say, ‘Since the time the IMF has signed each Asian bailout program, the respective Asian currencies have continued to plummet,’ said Jeffrey Sachs."
Jeffrey Sachs (The Economist, September 12, 1998, p. 23) "Global Capitalism, Making It Work. "Global capitalism genuinely is the best chance for the developing world to gain a foothold on the economic-growth ladder; but with current institutions, global capitalism will not succeed widely enough or credibly enough to create a stable world system…. The IMF bought into the investment bankers’ mantra: exchange-rate stability above all else…. The more these economies tried to defend their currencies, the more they incited panic."
George Soros (The Wall Street Journal, September 15, 1998, Op. Ed) "The Crisis of Global Capitalism. …there remains the urgent need for Congress to authorize an increase in the capital for the IMF….Bailouts did encourage foolish behavior by banks and other lenders, which could count on the IMF when a country got into difficulties (a moral hazard problem). But, the moral hazard now operates in the opposite direction, in not enabling the IMF to do its work when it is most needed."
Henry Kissinger (Washington Post, October 5, 1998, p. A21) "Perils of Globalism, The IMF is no longer suited for dealing with economic crises. The IMF must be transformed. It should be returned to its original purpose as a provider of expert advice and judgement, supplemented by short-term liquidity support…. Regulatory systems should be strengthened and harmonized; the risks that investors are taking should be made more transparent.
John Maynard Keynes, 1931 "We are today in the middle of the greatest economic catastrophe of the modern world…the view is held in Moscow that this is the last, the culminating crisis of capitalism and that the existing order of society will not survive it." As quoted in The Economist (September 5, 1998), page 19.
(15) 3.) The growth accounting equation is (Y is aggregate GDP in real terms):
Growth rates of K (capital) and N (labor) are weighted by their respective income shares, so that each input contributes an amount equal to the product of the input?s growth rate and their share of income to output growth. The ? indicates the change in the variable.
Growth Accounting Equation In Per Capita Terms:
(a) Define the notion of steady state equilibrium for the economy that is the combination of per capita GDP (y) and per capita capital (k) where the economy will remain at rest, or where per capita economic variables are no longer changing OR
In steady state, at what rate will GDP (Y) grow?
(b) Explain why, in the Neoclassical growth model, an increase in the savings rate does not increase the growth rate of per capita output in the long run.
(c) Explain why:
(1) An increase in the rate of growth of the population, n, reduces the steady state level of k and y
(2) An increase in n increases the steady state rate of growth of aggregate output
(1) A decrease in n increases the steady state level of k and y
(2) A decrease in n decreases the steady state rate of growth of aggregate output.
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