Int Macro Final

Question 1

Types of variables that move with the economy:

Answer 1

• Procyclical- rise as the economy rises
• Countercyclical- fall as the economy improves
• Acyclical- does not move with the economy

Question 2

Types of economic indicators:

Answer 2

o Leading- they change before the overall economy changes
o Lagging- they change after the overall economy changes
o Coincident- change at the same time as the economy changes

Question 3

What shifts the IS curve?

Answer 3

o “animal spirits”- irrational unexpected optimism or pessimism
o Events that encourage consumers or businesses to spend more or less
o Changes in G or T

Question 4

What is the Theory of Liquidity Preference

Answer 4

 How much money people want to hold based on the interest rate
o States that the interest rate adjusts to balance the supply and demand for money

Question 5

What shifts the LM curve?

Answer 5

o Changes in the money supply
-Increasing the money supply shifts LM to the right
o Changes in money demanded, other than a change due to Y, More D shifts LM left, less shifts it right.
o Changes in liquidity preferences

Question 6

Spending multiplier:

Answer 6

^Y=1/1-mpc

Question 7

Tax Multiplier:

Answer 7

^Y=mpc/1-mpc

Question 8

In the Dynamic AD model what shifts AD and AS

Answer 8

AD:M (adjusts) and V (reverses)
Short Run Aggregate Supply Curve
-A short run relationship between inflation and economic growth
Adjusts up or down based on inflation after AD has changed.

Question 9

Phillips Curve

Answer 9

a short run empirical relationship between inflation and unemployment

Question 10

Ricardian Equivalence:

Answer 10

when government tries to stimulate demand by using debt-financed government spending, demand remains unchanged
 This is because the public will save its excess money in order to pay for future tax increases that will be initiated to pay off the debt

Question 11

Problems with activist monetary policy

Answer 11

o Zero lower bound- the conundrum faced when interest rates are at, or near zero which leaves the Fed unable to effectively lower interest rates to promote expansionary policy
 Liquidity trap- when interest rates are low and savings rates are high

Question 12

Problems with monetary and fiscal policy:

Answer 12

o Forecasting is difficult
o Lags
o Lucas critique

Question 13

Taylor Rule-

Answer 13

monetary policy rule that stipulates how much the central bank should change the nominal interest rate in response to changes in inflation, output, and other economic conditions

Question 14

Marxian Business Cycle Theory

Answer 14

 Commodities are exchanged for money, but that money is not always immediately spent, instead some is saved
 Some exchanges or contracts take place over time
o In the future, prices may have shifted such that one party has difficulty completing its side of the contract
o If there is a network of contracts, this harm propagates to other contracts
o Creates systematic risk

Question 15

Austrian Business Cycle Theory

Answer 15

 Central banks cause business cycles by pushing down interest rates
o This leads to an expansion of credit which in turn leads to overinvestment
 Firms overinvest in long term projects as a result of unnaturally low interest rates and money illusion
o Production shifts from consumption goods to investment goods
 Firms eventually realize that these investment were mistakes

Question 16

Krugman on Hangover Theories

Answer 16

 Krugman believes that recessions are caused by excess demand for money
 Paul Krugman has issues with some of the aspects of the Austrian Business Cycle Theory
o If the Austrian Theory is true, why do recessions cause contractions in all industries?
 Why do industries that focus on consumption goods not just stay steady, they somehow shrink during recessions?
o Why doesn’t production shift back to consumption goods from investment goods?

Question 17

Market Monetarism

Answer 17

 Sumner and most market monetarists focus on targeting the level of Nominal GDP (NGDP)
o The Fed should inject as much money as needed to reach its goals
o Money affects the economy in ways other than interest rates
 Money has direct effects on spending
 Monetary policy works through expectations

Question 18

Why are Prices Sticky?

Answer 18

1. Menu Costs
2. Norms - our ideas of what is acceptable(prices/wages)
3. Contracts

Question 19

GDP Deflator

Answer 19

(Nominal GDP/Real GDP) x100

Question 20

Asymmetric Information:

Answer 20

Adverse selection and moral hazard

Question 21

Law of One Price

Answer 21

o In the absence of trade and transaction costs, the real exchange rate would be 1 due to arbitrage

Question 22

Purchasing Power Parity Law

Answer 22

• countries should adjust nominal exchange rate to keep the purchasing power of a currency stable, relative to other currencies

Question 23

The Policy Trilemma

Answer 23

It is impossible to have all three of the following at the same time:
 A stable foreign exchange rate
 Free capital movement
 An independent monetary policy

Question 24

Why peg the exchange rate?

Answer 24

o To increase exports
o Stabilize exchange rates
o Stabilize inflation

Question 25

Fisher equation

Answer 25

r= i - ii^e

Question 26

Define the golden rule steady state

Answer 26

• k that maximizes consumption

where the slope of the production function (MPK) is equal to the slope of the depreciation line (δ). at steady state

Question 27

Crises have some common characteristics:

Answer 27

1) Initiation of financial crisis
2) Banking Crisis
3) Debt Deflation

Question 28

Great Depression:

Answer 28

Due to stock market bubble bursting and animal spirits, investment spending falls.

• Banks fail due to bank panic and branching restrictions,
• Fiscal policy was mildly expansionary under Hoover, and initially mildly restrictive under Roosevelt, and later expansionary.
• NIRA and AAA imposed real negative shocks on the economy
• Smoot-Hawley tariff imposed a negative real shock and triggered retaliatory tariffs

Question 29

Great Recession:

Answer 29

1) Financial Innovation: new subprime mortgages, CDOs (or MBSs),
2) Housing bubble bursts:
3) Policy Responses:
a) Monetary policy:QE 1, 2, and 3
b) Fiscal policy
i) Economic Recovery Act of 2008
ii) Economic Stimulus of 2008