Macroeconomics Assignment

QUESTIONS

Section I TRUE/FALSE

State whether the statements below are true or false and explain your answer in detail. If you are uncertain, make sure that you explain why.

1. In the classical model, the rate of interest is determined by the investment and the saving functions. However, in the Keynesian model, the rate of interest is determined by the equality of aggregate output (GDP) with aggregate expenditure (Y=C+I+G).

2. When the economy is suffering from a liquidity trap (described in Keynesian economics as a situation where injections of cash into the private banking system by a central bank fail to decrease interest rates which results in monetary policy being ineffective) the demand for money is perfectly elastic with respect to the rate of interest. Therefore, an expansionary monetary policy will lower the rate of interest and increase aggregate output.

3. The quantity theory of money shows that money supply is perfectly correlated with the price level. This is true when there is unemployment in the economy.

4. Monetary and fiscal policies can often change simultaneously. In the early 1980's, the U.S. government cut taxes and ran a budget deficit and the Federal Reserve pursued a contractionary monetary policy. Given that the government's goal was to raise investment while keeping output constant, the policy they chose was adequate in helping the government reach their goal.

Section II Short Answer Questions

1. How do shifts in aggregate demand lead to short run fluctuations? Explain and support your answer with the adequate graph. Explain what happens in the AD-AS model if there is a negative supply shock such as an increase in the oil prices. What do you think are the causes of stagflation in an economy?

2. Imagine that you are elected the Chairman of the Fed and your goal is to keep both unemployment and inflation under control. This means that unemployment should be at its natural rate (e.g. 5%) and inflation at/around 2%. Can you achieve the two goals simultaneously? Why or why not? Explain in detail.

3. As a result of the fall of the "iron curtain" in 1989, many Americans felt less threatened by Russia and called for massive reductions in the defense budget as a "peace dividend".

Suppose that the defense budget had been cut by one-third, or about $100 billion. If no other policy changes are enacted, use an adequate model to analyze what would happen to output and the interest rate. Illustrate the changes that would occur by graphing the adequate curves and indicating their shifts and their economic meaning.

Section III Analyze critically and in detail the statements below:

1. Happiness surveys seem to indicate that at any given moment in time those with higher income, on average, report higher levels of happiness than those with lower income. Over time, nevertheless, as societies increase their real per capita income, average happiness does not seem to increase. This statement illustrates a rather odd combination of outcomes. Explain in detail.

2. "Mr. Trump's election has not altered the Fed's short-term plans. Ms. Yellen made clear in her testimony that the central bank remained likely to raise its benchmark interest rate at its next meeting, in mid-December".http://www.nytimes.com/2016/11/18/business/yellen-federal-reserve-congress.html?_r=0

Use the knowledge acquired in this class to give a thorough explanation why you might agree or disagree with the Fed's decision of increasing interest rates. In your explanation list and clearly explain the cost and benefits of your suggested monetary policy approach.