Assignment

Part 1

1. Show how to derive the AD curve from the IS-LM curves. Use this picture to show what happens to the AD when there is a tax increase.

2. What is meant by the "neutrality of money"?

a. Under which AS curve is money neutral?
b. Under which AS curve is money definitely not neutral?
c. Using IS-LM-AD-AS curves, illustrate the case of money neutrality.

3. What is meant by 100% crowding out of fiscal policy?

a. Under what AS curve is there 100% crowding out?
b. Under which AS curve is there the LEAST amount of crowding out?
c. Using IS-LM-AD-AS curves, illustrate the case of 100% crowding out.

4. What is meant by the velocity of money? Using FRED, obtain a graph of the velocity of money (M1). What has happened to velocity since the Great Recession?

Part 2

1. What are the two basic building blocks that provide the underlying foundation for the AS curve?

2. Show how to derive the modern AS curve from its underlying foundations. What assumptions are you making in your description of the labor market? Are these realistic, why or why not?

3. Explain why an increase in money wages shifts the modern AS curve to the left.

4. Show how to derive the classical AS curve from its underlying foundations. What assumptions are you making in your description of the labor market? Are these realistic, why or why not?

5. What would make the classical AS curve shift to the right? To the left?

Part 3

1. Draw the complete IS-LM-AD-AS-Labor Market-Production Function pictures of the economy. Label every axis and every curve. What are the endogenous variables? What are some variables that are exogenous?

2. What is meant by a demand shock? Give an example of a positive demand shock and a negative demand shock.

3. Suppose an economy begins at full employment and there is a sudden drop in consumer spending due to worries about global stability. Predict what will happen in the short run to Y, r, P, L and W/P assuming W is fixed.

4. What is meant by a supply shock? Given an example of both a positive and negative supply shock.

5. Using the long run vertical AS curve, suppose a war destroys half of the country's capital stock, reducing the productivity of labor. What will happen in the long run to Y, r, P, L and W/P?

Part 4

1. Milton Friedman said that "Inflation is always and everywhere a monetary phenomenon". Does this mean that every inflation is caused by excess money creation? If yes, explain why. If no, what does he mean?

2. Suppose that actual and expected inflation are both 3%. If the nominal interest rate is 4%, what is the real rate? If the real interest rate is 2% what is the nominal rate?

3. Can interest rates ever be negative? Why is it important to distinguish nominal from real rates in answering this question?

4. What rate of inflation does the FED try to achieve? Why isn't this rate 0%?

5. Which is worse for an economy, inflation or deflation? Explain.

Part 5

1. Using pictures, explain the difference between demand pull and cost push inflation.

2. Draw a traditional Phillips curve. What does it imply is the usual relationship between inflation and unemployment? What monetary and fiscal policies would lower unemployment while increasing inflation?

3. What is meant by stagflation? Show stagflation in a Phillips curve diagram. What US decade showed stagflation?

4. Explain the difference between the short run and the long run Phillips curve. What does short run mean here? What does long run mean here?

5. Define each of the following types of unemployment: frictional, structural, natural, cyclical. Give an example of each one.

Part 6

1. What is meant by the natural rate hypothesis? What does it imply about monetary policy in the short run? In the long run?

2. Suppose an economy is experiencing high inflation. How might a policy of "inflation targeting" help the Central Bank permanently reduce inflation?

3. What is the "dual mandate" of the Fed? Be specific as to how the Fed defines each arm of its dual mandate.

4. What is the rules versus discretion debate? Relate this to "the fool in the shower" and "time inconsistency"

Part 7

1. Why don't we define economic growth as the percentage increase in nominal GDP?

2. Suppose Nominal GDP rises 6%, inflation is 2% and population growth is 1%. What is the rate of increase of real GDP? Real GDP per capita?

3. What is the rule of 70? Explain how it is useful to compare growth rates across two countries.

4. Using FRED, find real GDP for the year of your birth and for 2016. By what percent did real GDP increase in your lifetime? What was the average annual rate of growth over your lifetime?

Part 8

1. In a Solow growth model suppose the production function is y = square root of k, where y = Y/L and k = K/L. If the economy saves 15% of its income and 5% is the rate of capital depreciation, find the steady state living standard. If the saving rate increases to 30%, what happens to the living standard?

2. Redo problem number 1, but assume that population and the labor force each grow 2.5% per year.

3. In the US, real GDP growth over the long run has slowed from about 3% to 2% per year. How would the Solow model explain this?