Unit 17

Question 1

What’s this unit about

Answer 1

Use models we have to analyse and explain economic history

Question 2

What kind of crisis was the Great Depression?

Answer 2

Due to an AD crisis after the stock market crash

Question 3

3 positive feedback mechanisms:

Answer 3

• pessimisms about the future - higher savings ratio
• failure of the banking systems = higher interest rates from non failed banks - worried about risks of lending
• deflation - delayed consumption

Question 4

Government response to GD

Answer 4

Government purchases - taxation or subsidies
- hoover administration said balance the budget and not intervene
- Roosevelt stepped in and you can see government purchases increases significantly.

Question 5

Effects after GD

Answer 5

• expectations fall, values of homes fall, increase savings and reduce consumption = cut in AD
  1933 - reduction to savings to restore wealth and spending - boosting consumption

Question 6

Fiscal policy in GD

Answer 6

Not much until WW1

Question 7

Monetary policy and gold standard during GD

Answer 7

The new deal - increasing government spending, left gold standard and reformed the banking systems - more difficult for banks to go bankrupt = higher social confidence

Question 8

Real r =

Answer 8

Nominal r - inflation rate

Question 9

Can’t cut nominal interest rate as

Answer 9

Deflation means real IR is higher than nominal IR, so cut = higher real interest rate than nominal

Question 10

Left gold standard because

Answer 10

Consumers may want to take their money out of dollars into US gold as it is more stable.
- therefore they kept nominal IR high to incentivise saving in US dollars
- but this prevented them from cutting their IR rates in order to not lose their gold reserves, so they left the Gold Standard

Question 11

After WW2 + GD

Answer 11

Golden age of capitalism

Question 12

Why golden age of capitalism?

Answer 12

• increased size of government - increased unemployment benefit and more welfare state concepts, automatic stabilisers, Breton woods agreements - tied exchange rates to the US dollar, so devaluations are permitted
• higher worker confidence due to above point, as well as higher union membership led to outward shift in WS curve

Question 13

Golden age of capitalism p2

Answer 13

• post tax profits remained high = more investment and technological progress = more job creation = more employment
• higher worker power but due to accords unions refrain from using full bargaining power so employers maintain investment at sufficient levels to keep UE low
• W = lamda(1-u), higher lamda = PS +WS curve shifts up = higher wage and employment

Question 14

End of golden age.

Answer 14

• low unemployment means workers demand drive profit rate down - pie stopped getting bigger at the same rate, so rate of increase of lamda slowed as there was now a contest of the size of rewards - so postwar accords collapsed
• lower profits = lower investment + prod = reduce rate of increase of lamda

Question 15

End of golden age impact on diagram

Answer 15

• upward shift in WS curve
• downward shift in PS curve, as price level is increasing, pushing real wage down
• leads to big bargaining gap, increase of nominal wages, then increase prices by same amount - shifting to a new Philips curve

Question 16

Ending stagflation - supply side policies

Answer 16

• restrictive monetary and fiscal policy - allowing unemployment to rise
• cut in unemployment benefits and reduction in trade union power = closed the bargaining gap

Question 17

Owners around 1970 started taking all profits =

Answer 17

• rising inequality
• post tax profit rate increased
• investments only responded weakly to profit incentives
• rate of growth of capital stocks declined

Question 18

After stagflation ended - great moderation occurred:

Answer 18

• low and stable inflation
• falling unemployment
• financial deregulation
  BUT
• rising household and financial sector debt
• Higher house prices
• Rising inequality = consumption funded by loans

Question 19

Cons of financial deregulation

Answer 19

• banks extend more loans for housing and consumer demands
• buy more financial assets based on bundles of home loans
• higher leverage rates
• credit rating agencies give high ratings to assets created from subprime mortgages.

Question 20

Housing market cycle

Answer 20

Household borrowing increases = purchases of housing increases = house price boom = higher value of collateral = higher household borrowing = …

Question 21

House price curves show

Answer 21

• if we get a positive shock to house prices, we run away to higher prices
  But, shallower price dynamic curve shows an increase in price shock would lead to prices reaching back to equilibrium = stable

Question 22

What does the S curve illustrates

Answer 22

What happens when price increases or decreases with upper and lower bounds
- if people lose faith in price of housing, whole S could shift down - no longer crossing the lines several times, if only once - could lead to a volatile crash

Question 23

Timeline of financial crisis 09

Answer 23

before crisis build up - lower residential investment
During crisis - consumption and all investment falls
Recovery - fiscal policies incentivised consumption which led to huge spike in consumption.

Question 24

Role of banks during 09 crisis

Answer 24

• closer to insolvency or highly leveraged = vulnerable to fall in value of financial assets
• higher liquidity risks as banks more reluctant to lend each other money - credit crunch
• fire sale of assets
• government bail out

Question 25

Which of following starts are potentially available to houses but not banks during credit crunch financial crisis 09
- Delay payment to creditor
- borrow
- Sell one or more assets

Answer 25

• true, houses can, but banks have obligation to settle on demand when clients wish to withdraw.
• only way banks can raise funds instantly is money market, which was inoperative during the crisis.
• true, banks would not have the time to seek out a fair price for its assets.

Question 26

Central bank would be expected to repond to increased price comp among firm businesses

Answer 26

Reducing interest rates