Econ Test 2...2 Flashcards
Referring to Davidson’s capital market diagram, Harvey says that ps is an important benchmark even when?
This price is a key benchmark even if there is not a single, solitary unit of existing capital actually for sale.
According to Harvey, which of Davidson’s prices is that which entrepreneurs would be willing to pay for a unit of existing capital? Which is the price they must pay to have new capital built?
a) The Demand Price b) The Supply Price
Echoing Davidson, Harvey says that investment will inevitably decline because of the continuous additions to the capital stock. Why will this not lead to a stationary state and what happens instead?
This will not be the case because falling investment will have shifted D down to D’, disappointing the expectations represented by Φ. Agents had undertaken the investment decisions represented by the intercept of D on the assumption that the economy would at least remain at N1; but, it has fallen to N2. Entrepreneurs are rudely reminded that never had a firm basis for their expectations in the first place and their error of optimism “is replaced by a contrary ‘error of pessimism’
What is the hope of those who favor functional finance?
The hope of those who favor functional finance is that the government will decide on its level of spending and taxation, running deficits of surpluses to keep the total level of spending in the country on goods and services, neither greater nor less than the rate which would buy all the goods it is possible to produce.
Explain in your own words how automatic stabilizers operate in a recession (two factors).
If the economy faces a down-turn, tax receipts go down while the government pays more money to the private sector in the form of unemployment transfers. As a result, purchasing power is impacted less that it would be in an unregulated economy.
What are the two fears that the public associates with rising government debt?
1) today’s debt will burden our children and grandchildren who will have to pay off the debt.
2) The government will finance the debt by printing money which will result in runaway inflation.
What is the moral of the history of the national debt from the Depression through WWII?
The moral is that there is nothing to fear about running big government deficits when, during a recession with significant unemployment, the federal government is the only spender that can take the responsibility to sufficiently increase the market demand for the products of our industries, and thereby maintain a profitable entrepreneurial system.
Our desire to hold money as a store of wealth is a barometer of what?
It is a barometer of the degree of our distrust of our own calculations and conventions concerning the future.
Uncertainty and unwillingness to commit all one’s earned income to current purchases of producibles will do what and when?
It will cause unemployment, if, and only if, the object of the savers’ desire is a resting place for their savings that is nonproducible and not readily substitutable for producibles, even if prices are flexible.
Without what would real world entrepreneurial activities quickly wither away
Animal spirits
In the General Theory, Keynes distinguishes what three motives for holding money? Please explain each briefly. Also note which one Keynes’ later admitted was misspecified.
1) The Transaction Motive- the need for cast for the current transaction of personal and business exchanges
2) The Precautionary Motive- the desire for security as to the future cash equivalent of a certain proportion of total resources
3) The Speculative Motive- the object of securing profit from knowing better than the market what the future will bring forth.
Keynes admitted that the transactions demand for money was messpecified, and he rectified his error by adding a fourth category for demanding money, the finance motive.
Draw the speculation demand curve for money as shown in Figure 7.3 (you may exclude the exogenous money supply curves). In your own words, why does it have that slope?
If interest rates are relatively high, then market participants will be bullish. If however, they are low then participants will expect them to rise and so will behave bearishly. The first situation will give us poin A and second point B. Connecting those two points, gives us the downwards sloping demand curve shown on the graph.
Keynes later realized that omitting the finance motive from the General Theory was a mistake. In discussing it, he said that if contractual commitments to buy new capital per period were unchanged, then the money held to “finance” the production of new capital goods was more or less constant and could be lumped under the transactions motive. But, and here was the novel and important part of the transactions motive, he also said that if decisions to invest are increasing, then he says that the demand for money to pay for production of these additional investments at any given interest rate will increase when?
Even before any additional employment and income are generated.
According to Keynes, who holds the key position in the transition from a lower to a higher scale of economic activity and what happens if they refuse to relax? The investment market can become congested through what and not through what?
The banks hold the key position in the transition from lower to a higher scale of economic activity and if they refuse to relax, the investment market can become congested through a shortage of cash and not through a shortage of savings.
Davidson argues that the money supply is endogenous, or created automatically in response to private market activities (central banks generally play only a passive role). In your own words, how has this, combined with the fact that production takes time (and the finance motive), led some empiricists to incorrectly infer that an increase in the money supply “causes” an increase in output?
Because production takes time, changes in measured output flows will tend to lag behind changes in the volume of outstanding bank loans. This calendar sequence of events has led some empiricists to infer incorrectly that an increase in the money supply causes an increase in output.
Very briefly, in what sense is the existence of liquidity-creating financial markets a double-edged sword (good times versus bad times)?
The existence of liquidity-creating financial markets is a double-edge sword that in good times facilitates investments in real capital goods but in bad times adds greatly to the instability of the system.
The fast exit strategy that calms all financial asset holders’ fears of the uncertain future is available to all only as long as what (note that a market maker is, according to the Securities and Exchange Commission, “a firm that stands ready to buy and sell a particular stock on a regular and continuous basis at a publicly quoted price”)?
The fast exit strategy is available only as long as the vast majority of people do not simultaneously try to execute this exit or, if many try, they do not overwhelm the resources of the market maker attempting to maintain an orderly market.
With the repeal of the Glass Steagall Act in 1999, there was a tremendous growth in innovative financial derivative markets. What happened when events occurred to make most holders of these derivatives into bears and why?
Because there was no market maker, orderliness disappeared and the financial derivative securities became virtually illiquid
What is the result of the fact that minority shareholders have little knowledge or interest in the long-run prospective yield of capital assets that they legally own?
The result is that financial asset market valuations are a result of a convention established on the mass psychology of a large number of ignorant individuals
Davidson argues that security prices are not really reflective of the underlying fundamentals involved. Worse yet, those irrational prices from the financial sector have an impact on the real economy. What, for example, do depressed security prices retard and why? And what problem results when the spot price of titles to capital goods is high relative to the flow-supply (or production) price for real capital?
If security prices are depressed, it becomes possible to purchase the title to capital goods at a much smaller cost that producing new capital goods. This retards the formation of new capital goods as resources are shifted towards mergers and acquisitions. Meanwhile, if the spot price of title is high, then entrepreneurs are likely to take on extravagant projects because they are likely to turn an immediate profit. This practice quickly turns into an economic bubble.
What did Keynes say about the wealth effect of a change in the price of financial assets?
a country is no richer when it swaps titles to capital at a higher price than a lower one, but the citizens, beyond question, feel richer.
Shadow banking evolved as non-bank financial intermediaries created securitized assets that they claimed were nearly as good as money because they were so liquid and stable in value. Such claims were made with respect to the derivatives created from subprime mortgages (note that there is an omitted “not” in the last full sentence on page 158 in Davidson–I think you’ll know where!). In reality, it was next to impossible to determine the true value of the assets and in 2007-8, mortgagees began to default. Why did the mortgage originators have an incentive to approve people for those loans and why did they not care too terribly much whether or not they defaulted?
Mortgage originators were incentivized to make loans by the fees they received as well as to servicing mortgage payment receipts. They had little to fear in terms of default because they loans were quickly taken off of their balance sheets and put on the balance sheets investors, pension funds and mutual funds through a process called securitization.
In the 1990s, banks started selling their loans to non-bank intermediaries. While this allowed them to shed much of their default uncertainty, there was a downside. What was it?
Loan officers bank loan officers do not worry as much about the credit worthiness of borrowers as long as there is a strong market demand to hold these loans for their returns
What assumptions are made regarding M, V, P, and y in the “money growth ==>inflation” view?
M: That which is money is easily defined and identified and only the central bank can affect it’s supply, which it can do with autonomy and precision.
V: The velocity of money is related to people’s habits and the structure of the financial system. It is, therefore, relatively constant.
P: The economy is so competitive that neither firms nor workers are free to change what they charge for their goods and services without there having been a change in the underlying forces driving supply and demand in their market.
y: The economy automatically tends towards full employment and thus y (the existing volume of goods and services) is as large as it can be at any given moment (although it grows over time).
