Answers to Homework #3

Posted to the right and here.

Chinese Stock Market Crashing

The Chinese stock market is plunging. Given our discussion of financial markets, what might account for such a drop in value? (Recall that what matters are profits, the real interest rate, and the growth rate).

Inflation

This article talks about rising consumer prices. If you model this as a shift upward in the SRAS curve, what do you predict will happen to output in the short run and the long run? What will happen to prices long run?

Inequality Slides

Slides from class 4/17 on inequality.

America's Recession

It looks more likely that the U.S. will actually have a recession (that is, the economy may actually shrink in size). This analysis assigns blame to two things a) less lending and b) consumer spending slowing down (MPC falls). Looking just at the loanable funds market, does both of these make sense? (Hint: not really). So the lending slowdown must show up somewhere else - like the money demand function. This would be a great article to use for your final paper.

Problem Set #3 Again

Just a reminder, in case you missed class. Problem set #3 is due on April 10th (not April 3rd as listed on the syllabus).

Problem Set #3

Problem set 3 is now posted in the right-hand column under class materials.

For Future Reference

This commentary is about setting up a government infrastructure bank. We will talk in a few weeks about the causes and consequences of government debt. This article is about one aspect of that - is government debt a bad thing if it funds productive investments?

Falling Dollar

Martin Feldstein (really smart economist) has a commentary on the fall in value of the U.S. dollar. You can frame his argument in terms of the real vs. nominal exchange rates, and then think about how this relates to our large trade deficit.

Let's All Just Relax

Robert Samuelson tells us to calm down about the economy. Given our class on the Great Depression, how/why does he feel so little panic?

How did this happen?

The Economist has a nice article describing the conditions that led to the current financial situation in the U.S.. It's more complex than what we discussed in class, but it is a nice summary.

Icelandomics

What you've learned in this class doesn't just work in the U.S. This article discusses the situation in Iceland and how they are acting to try and rescue the value of their currency. Can they continually prop up their exchange rate? Why not?

Banks Raising Reserve Ratios

This article gets at the heart of the issue with a financial crisis - banks horde cash. So how does this work without our model of the money market and the IS/LM?

Chinese Slides

Powerpoint slides for todays class.

Spillovers

Apparently the Canadians are worried. Think about how poor economic performance in the U.S. might affect Canada - specifically, what might happen to their net export demand? Does this matter if they have perfectly flexible exchange rates? How about if they have fixed exchange rates?

Stagflation?

This editorial discusses the possibility of stagflation - that is, both rising unemployment AND rising inflation. How can both of these occur at the same time? Specifically, think about the AD/AS diagram. How can you generate both falling output and rising prices? Think about how rising commodity prices may be changing the SRAS curve.

Bernanke Asks for Easier Loans

In this article, the Fed Chairman asks for banks to renegotiate or forgive portions of mortgages that might default. In terms of our model of the money market, what is he trying to do to money demand (L)? How would this help the economy?

Bernanke Talks About Economy

A nice brief article on what Ben Bernanke is thinking about the economy right now. At this point, it should be relatively easy to frame his comments in terms of our IS/LM model.

Homework #2 Answers

These are now posted in the class column on the right.

Slides for 2/21/08

Slides for the class on the housing bubble and current downturn (recession?) in the U.S.

Subprime Mortgages Explained

This is informative, funny, and can be kind of offensive.

China and the U.S.

This link is to a longer article by James Fallows on how China is subsidizing American consumption. He gives a great explanation of how this works in practice, and then considers the ramifications. It is long, but well worth the read. I'd suggest that people might want to use this as the basis for their longer paper that is due at the end of the semester.

Monetary vs. Fiscal Policy

This article looks at what ability monetary policy has to influence output in the U.S.. If you're thinking about this, remember when we talked about the slopes of the IS curve and how that affects monetary policy. Steep IS curves mean monetary policy is less effective, and flat IS curves imply monetary policy is more effective. So what might be happening in the loanable funds market to make the IS curve get steeper?

Bailing out Banks

This article has relevance to our next class, on the current state of the U.S. economy and the sub-prime mortgage mess. It's pretty dense, but think about it in terms of the model of money creation we went over.

Homework #1 Answers

The answer key to the first problem set is posted on the right-hand column of this site.

New Homework

The latest homework is posted in the right hand column of this site. It's due February 26th.

Brazilian Macroeconomics

This article is a nice summary of Brazil's current economic position. If you're interested in reviewing it, hold off until we go through the material on open economy IS/LM models - they are more relevant that what we've learned so far.

By the way, this article is also a nice target to shoot for in terms of style and quality. It is well written and explains several economic concepts rather cleanly.

Recession?

This article reports that the administration is claiming the U.S. will not enter a recession in 2008. The rationale would be that the Fed lowering interest rates (meaning that money stocks are increasing), combined with the fiscal stimulus (the tax rebates, or T falling) will be sufficient to keep output from falling.

If you review this article, think of it in terms of our IS/LM model. How does the combination of increasing M and lower T shift around the curves and keep output up? What will actually happen to interest rates? Can we know for sure?

Old Midterms and Finals

If you go to this site, on my personal webpage, you will find links to old midterms and finals I have given. In some cases, there are answer keys posted as well.

One warning, there may be a little more math involved this semester, but not much.

Slides for 2/12/08

A few graphs used in the class on fluctuations.

The Purpose of Tax Policy

This post from Greg Mankiw doesn't necessarily related directly to our material in class, but it's an interesting analysis of what matters when we set taxes. One question is which of his four goals of tax policy you find most important? Which is the least important to you?

Alternative Trade Deficit Explanations

This editorial looks at the decline in the U.S. current account (basically, NX) and wonders whether Alan Greenspan's explanation is correct. The author describes Greenspan's theory, and then offers his own counter-theory. If you read through this, think about describing the two theories in terms of the loanable funds market. In particular, changes in the world interest rate versus changes in our savings rates.

Slides for 1/31/08

These slides are for our class on the U.S. trade deficit, and consist mainly of different graphs. We'll be going over them in class in detail.

More Trade Deficit Analysis

This text is from testimony given before Congress, and suggests the trade deficit is relatively benign. Is there anything that the author is not considering regarding the role of trade deficits?

Is the Trade Deficit Unsustainable?

Here's a review of an academic paper that suggests the U.S. could face severe consequences from running such large trade deficits. If you write a short article review of this, make sure you try and identify what the cost of these deficits are. Why would they be bad for the U.S.? Does our model in class allow for these kinds of costs?

Problem Set #1

Here is the link to the first problem set. There will also be a link to it in the right hand column of this web site. The homework is due February 5th, and covers material in Chapters 2, 3, and 5.

Chapters Assigned

People had questions on exactly what they should be reading in the book. Here is the breakdown according to the course outline in the syllabus.

1. Introduction, data and basic facts: Chapter 2
2. Income, Money and Open Economies: Chapter 3 (sections 1,3,4), Chapter 5, Chapter 4, Chapter 18
3. Short run fluctuations, building the IS/LM model: Chapter 10, 11
4. Open Economy IS/LM: Chapter 12
5. The Philips Curve: Chapter 13
6. Other aspects of the macroeconomy: Chapter 15, Chapter 6
7. Growth and development: Chapter 7, Chapter 8

Free Money

Here is an article describing the basics of the just-announced agreement on fiscal stimulus in the U.S. One thing you'll notice is that in addition to the rebate checks to individuals, there will likely be several provisions meant to lower taxes on businesses. An interesting question regarding this is: do businesses and individuals have different marginal propensities to consume? And if they do, how does this affect the power of this stimulus bill?

CPI Basket

We talked about the CPI in class. The CPI, you'll recall, measures the cost of a specific basket of goods (i.e. 4 apples and 3 oranges) over time. Issues with the CPI are that the basket doesn't necessarily represent what you or I actually consume. Attached here is the actual breakdown of the CPI basket by category in excruciating detail. The broad categories, and their percentage weight in the basket is:

Food and Beverages 14.99%
Housing 42.69%
Apparel 3.73%
Transport 17.25%
Medical 6.28%
Recreation 5.55%
Education and Communication 6.03%
Other 3.48%

You'll see that housing is the biggest category, followed by transportation and food. Does it makes sense? Depends on who you are.

Exciting Times

It may not be the best news for the macroeconomy, but financial panic and impending recession at least make things more interesting. Here's the article today from the Washington Post on the drop in global stock markets, the Fed's emergency rate cut, and the possibility that we'll head into recession.

The link between stock markets, the Fed, and recessions is something we'll address as we go through class. For now, you can think of it this way. If the economy is going along normally, then the financial markets are taking your savings and pushing them out to different firms who invest these funds (either by lending the firms money or by investing in the firms stocks). The firms who get your savings use them to hire more people, buy more machines, or buy their CEO a new gold bathtub.

When financial markets get panicked, though, they are wary of giving your savings to firms, because they think the money will disappear. So they essentially hide your savings under the mattress as cash, and firms don't have access to new funds to hire new people or buy new machines. So economic activity slows down.

The Fed is trying to induce the financial markets to keep lending. How? We'll get to that in the next couple of days.

Cool Maps

This map, from here, replaces every state with the name of the country that has a GDP of the same size. That is, Texas and Canada have the same total GDP. California and France have the same GDP. Illinois and Mexico have the same GDP. It is a nice indication of how big the U.S. economy is relative to the rest of the world.

And incidentally, if you were worried about Iran or Pakistan hoping to engage in some war of conquest, consider that this would be equivalent to either Alabama or Arkansas doing the same.

Here's the graph of CPI and the GDP Deflator over time. As you can see, they tend to move quite closely together. (Source: Mankiw's 6th Edition)

Stimulating What?

This is an interesting post about the goals of fiscal stimulus (i.e. tax cuts or more government spending). People generally feel that this kind of stimulus needs to take place soon, so that it can counteract the probably decline in GDP that is occurring right now. However, as the authors of the post point out, do we really care about GDP, or do we care about people losing jobs? If the stimulus package takes a long time to enact, maybe that is okay, because it will result in a stronger job market - which ultimately matters more directly to people.

Rising Inflation

We'll be talking in more detail about the kind of numbers quoted here. The article is pretty clear on the trade-off that the Fed faces in its decisions. Higher inflation vs higher growth of GDP.

Fiscal Stimulus

We'll get around to talking about this eventually, but here is an article regarding the role of the government in mediating recessions. The authors point out that fiscal stimulus (i.e. government spending or lower taxes) should fulfill three requirements:

1. Fiscal stimulus should be timely. (That is, the extra spending or lower taxes have to be put in place while the economy is actually heading into a recession, not afterwards. This is a problem because the Federal government tends to move very slowly.)

2. Fiscal stimulus should be well targeted. (That is, it should go to those people who need it the most - unemployed or under-employed people.)

3. Fiscal stimulus should be temporary. (Recessions are short-run events, so the stimulus does not need to stay in effect forever - just until the economy gets back to full employment.)

It matters how you count things

This article is a nice example of why we spend so much time learning how to count GDP. The upshot is that due to a different way of counting, we think China and India are about 40% smaller, in GDP terms, than before.

Slides from 1/15/08

Link here to get slides from first lecture, including graphs of GDP, inflation, and unemployment.

The Fed Chair Speaks

As reported here, Ben Bernanke is indicating that the Fed will likely drop interest rates at their meeting in January. A few quotes of interest, along with questions that you should be able to answer by the time we finish this course.

The Fed chairman said “we stand ready to take substantive additional action as needed to support growth and to provide additional insurance against downside risks”.

(How can the Fed support growth?)

He warned that the strains in financial markets “continue to pose a downside risk to the outlook for growth” with investors still uncertain about the true value of complex financial assets and about the extent of additional losses that may be disclosed in the future. The financial situation “remains fragile and many funding markets remain impaired” he said.

(To what extent can the Fed affect the attitude of the financial market?)

The Fed chairman did not discard the US central bank’s inflation concerns, warning that the renewed strength in oil prices was “lifting overall consumer prices and probably putting some upward pressure on core inflation measures as well”. He hinted that provided inflation expectations remained steady this would not get in the way of Fed easing, but said “we will be closely monitoring the inflation situation, in particular as regards inflation expectations”.

(Why is the Fed worried about inflation? And what do they have to do with it?)

The 4 Boneheaded Biases of Stupid Voters

The economic biases that we talked (or will talk) about in class are from an article by Bryan Caplan that you can read in full here. Feel free to use this article as the source of one of your short article summaries. (If you do so, go ahead and just focus on one of the 4 biases, you don't have to summarize the entire thing.)

To remind you what the biases were (are), here's a quick summary:
1. Anti-market bias - the feeling that any act that results in a profit for one person must be anti-social by definition. (If you think GM is ripping you off, then take the bus. Otherwise, be quiet).

2. Anti-foreign bias - the feeling that economic exchanges are "different" if they occur with foreign countries as opposed to with locals. (You run a trade deficit with GM when you buy a car. Should we put tariffs up between you and GM?)

3. Make-work bias - the feeling that there are a fixed number of jobs, in specific categories, to be filled. (In 1900, 40% of the people in the U.S. worked on farms. Now, its 3%. Are 37% of American's now unemployed?)

4. Pessimistic bias - the feeling that things are getting worse in general. (Since 1950 we've had 9 recessions. Since 1950 there have been exactly 6 years out of 57 in which GDP actually shrank. GDP per capita in the U.S. is 3.4 times higher today than in 1950.)