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2nd Year > Macroeconomics: Autumn Term > Flashcards

Macroeconomics: Autumn Term Flashcards

1
Q

Karl Popper quote on Scientific theories?

A

“The theories are passed on, not as
dogmas, but rather with the challenge to discuss them
and improve upon them”

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2
Q

When should a theory be considered scientific?

A

If and only if it is falsifiable (testable)

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3
Q

Definition of Economics?

A

The study of choices as they are affected

by incentives and resources.

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4
Q

Example of economic study and criminology by Becker (1992, Nobel Prize)?

A

Poverty is associated with greater criminal activity, Becker reasons, the poor have more to gain from crime than from doing a legal job. (Emphasis on rationality)

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5
Q

Why use mathematical models?

A
  • Imposes consistency to theory
  • Prevents contradictions
  • Rely on models for predictions
  • Allows for testing
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6
Q

Einstein quote on simplicity?

A

“Everything should be made as simple as possible,

but not simpler.”

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7
Q

What are business cycles?

A

Fluctuations of economic activity around a

long-term growth trend.

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8
Q

What are turning points in business cycles?

A

Peak: The last month before key indicators fall
Trough: The last
month before the indicators begin to rise.

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9
Q

What are persistent deviations from business cycle trends called?

A

Positive ones: Expansions (boom)
Negative ones:
Contractions (Recessions)

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10
Q

What is GDP?

A

Measure of national

income and input for a given country’s economy

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11
Q

What is the expenditure method for calculating GDP?

A

GDP is equal to the total expenditures for
all final goods and services produced within the country in a
stipulated period of time

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12
Q

Equation for GDP?

A

= C + I + G + (X- M)

consumption + gross investment + government spending +
(exports - imports),

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13
Q

Why is it gross investment when calculating GDP?

A

“Gross” means that depreciation of capital stock is

taken into consideration

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14
Q

What is the GDP implicit price deflator?

A

GDP in current prices (Nominal GDP) / GDP in base year prices (Real GDP)

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15
Q

Why do we use log transformations on time series data?

A

To handle exponential growth of a series and stabilize the variability

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16
Q

What type of variables should we consider taking logs of?

A

Variables expected to grow exponentially (like GDP, population, consumption)

Not variables expected to fluctuate around a fixed level around a fixed level
(inflation, interest rates, unemployment rates)

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17
Q

Why do business cycles occur?

A

Unexpected disturbances (Shocks in tech, oil, fiscal or monetary)

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18
Q

Why do Keynesian economists think cycles occur?

A

Due to nominal rigidities (wages, prices etc are not flexible in the short run)

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19
Q

What is the real business cycle theory?

A

Believe cycles are down to productivity shocks, modern markets are more flexible than Keynes thought

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20
Q

Keynes v Friedman on cycles?

A

Keynes: Gov should use policy to manage the economy which could moderate recessions
Friedman: Gov role in guiding economy should be restricted. (Monetarism- price level depends on money supply)

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21
Q

Why did Friedman think cycles was a misnomer?

A

-No regularity is amplitude, fluctuations or duration of the cycles.

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22
Q

What is regular in business cycles?

A

Comovements: macro variables move together in predictable ways

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23
Q

Comovement in an expansion?

A

Output rises, employment rises. Inflation may rise as well

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24
Q

Comovement in a recession?

A

Output of goods/services falls, employment falls

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25
Q

What is a procyclical variable?

A

The variable causes deviations from the trend that are positively correlated with the deviations from trend in
real GDP

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26
Q

What is a countercyclical variable?

A

The variable causes deviations from the trend that are NEGATIVELY correlated with the deviations from trend in
real GDP

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27
Q

What is an acyclical variable?

A

A variable uncorrelated with changes in GDP trends

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28
Q

Why is the growth rate of M2 important?

A

Positively correlated with growth rate of GDP. Money stock measures are available more quickly than GDP it is a good measure of the economy

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29
Q

What is the M2 variable?

A

M2 is a money supply measure which includes M1 (cash + cheques) as well as NEAR money ( savings, deposits, money market securities, mutual funds) which are assets than can quickly be converted to cash.

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30
Q

What is the IS relation?

A

Equilibrium in the goods market occurs when production (Y) = demand (Z)

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31
Q

Simple IS equation?

A

Y= C( Y-T) + I + G

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32
Q

What does investment depend on?

A

The level of sales (+)
The interest rate (-)

I= I( Y, i)

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33
Q

Why is demand an increasing function of output (for a given interest rate)?

A
  • Increase in output, increases income, people have more to spend on goods
  • Output increasing can increase investment
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34
Q

What effect does the interest rate have on equilibrium level of output?

A

Higher interest rate - lower demand for goods (at any output), decreasing level of equilibrium output
(IS curve shifts down)

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35
Q

Why is the IS curve downward sloping?

A

Increase in the interest rate leads to a decreasing output

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36
Q

What shifts the IS curve left?

A

Changes in factors that decrease the demand for goods (given the interest rate), e.g. taxes

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37
Q

What shifts the IS curve right?

A

Changes in factors that increase the demand for goods (given the interest rate)

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38
Q

What is the interest rate determined by?

A

The equality of the supply of and the demand for money

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39
Q

LM equation?

A

M/P = €YL(i)

Money stock= Demand for money (nominal income x nominal interest rate)

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40
Q

What makes up the demand for money?

A

Nominal income x nominal interest rate

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41
Q

What is the LM relation?

A

The real money supply with equal the real money demand (depends on income and interest rate) in equilibrium

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42
Q

What impact does an increase in income have on the interest rate (given money supply)?

A

An increase in income, increases demand for money. At a given money supply, this increases the equilibrium interest rate

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43
Q

Why is the LM curve upward sloping?

A

An increase in income, increases the interest rate

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44
Q

When does the LM curve shift?

A

When interests change but output doesn’t

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45
Q

What are open market operations?

A

The standard method Central Banks use to change the money stock

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46
Q

What is expansionary market operations?

A

When the Central bank buys bonds (increases the supply of money)

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47
Q

What is contractionary market operations?

A

When the Central bank sells bonds (decreases the supply of money)

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48
Q

What are assets for the Central Bank

A

Bonds

49
Q

What are liabilities for the Central Bank?

A

Money (currency)

50
Q

What is the price of a bond formula?

A

Price = (100)/(1 + i)

51
Q

When does the LM curve shift down?

A

When the money supply increases

52
Q

When does the LM curve shift up?

A

When the money supply decreases

53
Q

How does a monetary expansion effect the LM curve?

A

Shifts it down- higher output, and lower interest rate

54
Q

What is the liquidity trap?

A

At 0 interest rate (other than transaction money) people are indifferent to cash or bonds- demand for money becomes horizontal. Increases in the money supply have no effect on the interest rate (LM curve flat at low levels of output)

55
Q

Liabilities for a bank?

A

Value of checkable deposits

56
Q

Why do Banks hold reserves?

A
  • Deal with flow of cash withdrawals
  • Honour cheques
  • Reserve ratio laws (10% US)
57
Q

Assets of a bank?

A

Reserves
Loans
Bonds

58
Q

Demand for currency equation?

A

C(Ud) = c(Md)

59
Q

Demand for deposit equation?

A

(Dd) = (1-c)(Md)

60
Q

Demand for reserves by banks equation?

A

(Rd)= (coefficient of reserve to deposit demand)(1-c)(Md)

61
Q

The demand for central bank money is equal to?

A

The sum of demand for currency and demand for reserves

62
Q

Demand for central bank money equation?

A

(Hd)= (c + 0(1-c)) €YL(i)

63
Q

Equation for the money multiplier?

A

1/(c + 0(1-c))

64
Q

Overall supply of money formula including the money multiplier?

A

Multiplier x Central bank money = Money supply

65
Q

What does high-powered money mean?

A

Overall supply of money depends on the amount of central bank money (monetary base)

66
Q

Origin of the 2007 financial crash?

A

Started in the subprime mortgage market

67
Q

What is a solvency problem?

A

When the value of the assets decline under the level of liabilities (insolvency)

68
Q

What is a liquidity problem?

A

Bank has a difficulty repaying investors

69
Q

What is the leverage ratio?

A

Assets/ capital

70
Q

Why is a high leverage ratio risky?

A

As if the price of assets falls the bank could become insolvent

71
Q

What is the capital ratio?

A

Opposite of leverage

Capital/ assets

72
Q

What is securitisation?

A

The creation of securities based on a bundle of assets, loans or mortages

73
Q

What is MBS?

A

Mortgage based security: Returns from a
bundle of mortgages, with the number of underlying
mortgages often in the tens of thousands

74
Q

What is CDO?

A

Collateralised debt obligations: Risky securities offering high returns.

75
Q

What is SIV?

A

Borrows from investors, typically in the form
of short-term debt whilst holding various
forms of securities. Reliant on a bank as lender of last resort

76
Q

What is CDS?

A

Credit default swap: Insurance against the default risk

77
Q

Issues caused by securitisation?

A

The leverage of the financial system was much larger than had been predicted

78
Q

US actions after the crisis?

A

-Cut interest rates.
- Increased Federal deposit insurance from $100,000
to $250,000
• Provided liquidity
• Troubled Asset Relief Program (TARP).
• The Fed is still the main buyer of the mortgage-backed
securities

79
Q

Europe’s actions after the crisis?

A

(Slower to act than US/UK)
-Cut interest rates.
-Unlimited liquidity for European banks at a fixed interest
rate of maturities of up to an year.
-Increased types of assets ECB would exchange for cash
-Purchase of ‘covered bonds’ by the ECB.

80
Q

Why the slow recovery on the aggregate supply side?

A

-Decreased level of natural output, cannot go back to pre-crisis level

81
Q

Why the slow recovery on the aggregate demand side?

A

Limits to monetary/fiscal interventions. Liquidity trap, unconventional policies, pressure to reduce gov debt.

82
Q

Effect of expansionary monetary and fiscal policies?

A

Monetary: Higher inflation
Fiscal: Increased gov debt

83
Q

Do Banking Crises Affect Output in

the Medium Run?

A
  • Typically decrease output even in medium run but there is variation across countries.
  • Harder to Banks to get the money to the right borrowers
84
Q

Reactions of top economists to the crisis?

A

Krugman: Old texts for inspiration
Lucas: Look forward, don’t go backwards
Buiter: Economy too complex to model
Thaler: Economics needs a revolution (behavioural economics)

85
Q

Price of an asset equation (constant discount rate K)

A

Po = (E (D) + E(P)) / (1+K)

86
Q

What is the efficient market

hypothesis?

A

The idea that a crisis is always unforeseen as prices are determined by new information (so cannot be predicted)

87
Q

Evidence against market efficiency?

A
  • Seasonality
  • Small versus large stocks
  • Value versus growth stocks
88
Q

What can we do about the impact of crisis?

A

-Take prevention
measures to reduce frequency/impact
-Deal with pain when it does occur

89
Q

Why do Diamond and Dybvig say the financial sector is prone to crisis?

A

Banks have short term liabilities but invest in long term assets- making them vulnerable to bank runs

90
Q

Why do Allen and Gale say the financial sector is prone to crisis?

A

Interconnectedness of the system helps redistribute funds in normal times but leads to contagion when there is a liquidity shortage.

91
Q

What is the Diamond and Dybvig model?

A

Showing the banks gamble with patient/impatient depositors- showing how bank runs can easily occur if people withdraw earlier than expected

92
Q

How can bank runs be prevented?

A
  • Government legislation on leverage and risk
  • Pay early withdrawals less
  • Suspend payments
  • Lender of last resort
  • Bailout
  • Deposit insurance
93
Q

What is a moral hazard?

A

When a person takes more risks because someone else bears the burden (insurance)

94
Q

What is a complete market?

A

Each region is connected to all the other, impact of a crisis may be small/thin as each area liquidates a small amount of a long asset

95
Q

What is an incomplete market- issues in a crisis?

A

Each region is connected only with a small number of regions. A crisis is felt strongly in neighbouring regions, this leads to large liquidations of long assets. Thus affecting other regions- leading to contagion

96
Q

A solution to contagion in incomplete markets?

A

Breaking the financial system e.g. PRA in the UK has to ring fence retail arms from rest of banks operations
(Glass-steagall Act, 1932 did this in US, until it was repealed in 1999)

97
Q

How can a central bank mitigate crisis in incomplete markets?

A

Can be the lender of last resort, and by intervening appropriately can prevent inefficient liquidation of assets.

98
Q

Why do asset prices end up above the fundamental price?

A

When agents purchase assets with credit they have limited liability (can go bankrupt and not pay it back if it goes badly). Incentive to overbid. (Same with stocks)

99
Q

Why do bubbles appear in riskier assets?

A

The riskier the asset the larger the bubble as there is more incentive for the agent to overbid.

100
Q

Why can no bubble exists forever?

A

As the supply will adjust eventually

101
Q

What impact does lower interest rates have on bubbles?

A

They increase the size of the bubble

102
Q

What lowered interest rates in 00’s?

A
  • Loose monetary policy in the US Fed’s response to the dotcom bubble
  • Global savings glut (Excessive saving in China invested in the US)
  • Financial innovation allowed banks to take more risks
103
Q

Why does a fall in asset prices lead to recession?

A
  • When asset prices go down, everyone can borrow less, lower output and further price falls in assets etc
  • Known as the Financial Accelerator
104
Q

Why was 2007/8 crisis worse than 2000 crisis?

A
  • Residential investment in the US = 6% GDP
  • Spending in IT sector in 2000 = 1.5% of GDP
  • Less leverage in IT sector
  • Larger IS shift left in 2007
105
Q

How can a fall in asset prices affect a bank’s leverage?

A

The fall in asset prices, increase the leverage for a bank and increases the risk premium (ROE= ROA x A/E)

106
Q

Factors other than asset prices which affect the risk premium?

A

Complexity: Securities poorly assessed. Toxic!
Liquidity: Banks reliant on term debt
Amplification: As the crisis got worse fire sales caused more problems

107
Q

How do bank reserves change in a crisis?

A

They increase as banks start to hoard excess liquid reserves due to fears about lending

108
Q

Why do Banks hoard liquidity in a crisis?

A
  • More reserves = less exposure to losses
  • Call in unused loan commitments
  • Flight to quality
109
Q

What does Keynesian theory suggest about the multiplier in a liquidity trap?

A

It is very large!

Large increase in output, without crowding out of private activity because of the low interest rate.

110
Q

Why are temporary monetary
expansions not very effective in a
liquidity trap?

A

They only affect interest rate but not output

111
Q

Why is a negative interest rate necessary to restore Y (output)?

A

To allow households/firms to repay large debts resulting from buying assets at inflated prices

112
Q

Why hasn’t QE been enough?

A
  • Coordination problems (Banks not lending to the same people)
  • Expectation problems (Fear QE will be reversed, increasing risk premiums)
113
Q

Examples of modern challenges to Keynes?

A
  • Animal spirits (RBC models explain volatility with rationality)
  • Keynes uses current income in his multiplier, Friedman favoured permanent income
114
Q

Examples of modern challenges to Marx?

A

-Crisis do not seem punishment on inequality (Sweden crisis in 1990s)

115
Q

Examples of modern challenges to Hayek (gov intervention to blame for crisis)?

A

-Sichel, post WW2 “expansions became longer… contractions became
shorter”
-Recessions less severe (12% fall in industrial production post 1913, 9% fall after WW2)

116
Q

What is the aggregate supply equation?

A

P= (Pe) (1 + u) F(U, z)

Price = expected price level and the unemployment rate

117
Q

Equation for the unemployment rate in terms of output?

A

u = 1 - (Y/ L)

Higher output leads to lower unemployment

118
Q

What shifts the aggregate demand curve?

A
  • Right when government spending increases

- Left when there is a decrease in nominal money

119
Q

Why does an increase in the price level

lead to lower output?

A

Price rises, M/P falls, interest rate rises, demand falls, and output falls

2nd Year (8 decks)

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