# Macro Final

Quiz by Cindy Nguyen, updated more than 1 year ago
 Created by Cindy Nguyen over 2 years ago
10
0

### Description

Practice quiz for the remaining parts of the lesson before the final

## Resource summary

### Question 1

Question
Three-sector Macro Model (aka Transmission Mechanism for M Policy) Money market, [blank_start]Investment[blank_end] decisions, AE What are the links between money and the real world? I = I(E profit, i, confidence) Who makes I decisions? [blank_start]Businesses[blank_end] (real I, if not otherwise qualified, I means real I) Remember, housing construction is the most interest-sensitive. That’s why Keynes argued that it wasn’t movements along the I schedule, but [blank_start]shifts[blank_end] in it, that were important. The volatility of investment was key to understanding changes in economic activity. How to use the 3-sector model: read it [blank_start]left[blank_end] to [blank_start]right[blank_end] Note, can’t just read across from i to i to A on vertical axis, Higher interest rate will mean [blank_start]lower[blank_end] A, [blank_start]lower[blank_end] GDP If you want to common-sense double check, higher interest rate will mean lower GDP. Exogenous shifts in 3-sector model (Money market, I(i), AE)
• Investment
• Saving
• Consumption
• Government
• Individuals
• shifts
• decreases
• increases
• left
• right
• up
• down
• right
• left
• up
• down
• lower
• higher
• lower
• higher

### Question 2

Question
Reading the 3 sector model: 1) Any event originating in the [blank_start]money market[blank_end] (shifts Dm or Sm) will cause a change in (i). Therefore the change in (i) causes a change in (I) as we [blank_start]move along[blank_end] I(i) schedule. Therefore the change in I causes a change in A and shift in AE, new equilibrium y*. This model shows the Transmission Mechanism for Monetary Policy. When the Fed buys bonds, by what path does that impact on the real economy? The 3-sector model provides the answer. 2) Any event originating on the I schedule. I = I(E, (i), state of confidence): change in underlined explanatory variables will [blank_start]shift[blank_end] the entire I(i) schedule Notice that for any course you take, if there is a graph representing a causal model, with an explanatory variable on one axis and a dependent variable on the other axis, a given change in the explanatory variable moves you along the curve or line on the graph. That’s what the graph shows you, the relationship between the two variables. If there is a change in a causal variable that is not on the graph, then the whole curve must shift. So a change in E, or a change in the state of confidence, will shift the entire I(i) schedule out or in. At the initial interest rate, there is now a higher or lower level of real I. The [blank_start]interest[blank_end] rate does not change, it is given by the money market. But the shift in the schedule causes I to change. 3) Changes that originate on the AE diagram, the Keynesian-Cross model, include changes in Ca (not I), G, T (-mpcT), EX, IMa. These will change A, shift AE, new equilibrium GDP, that’s it.
• money market
• investment schedule
• AE
• Consumption
• PPF
• move along
• shift
• shift
• move along
• interest
• investment

### Question 3

Question
Crowding Out: [blank_start]Monetarist[blank_end] claim that government spending (and borrowing) crowds out private investment, which therefore falls. If the government expands G without T, it has to borrow money to do so, There’s a [blank_start]higher[blank_end] MDT. To show this using the model we have to shift AE, find y*, then jump back to the M market and show that MDT rises, and trace that through all 3 sectors again Different assumptions about M market lead to different conclusions about the Crowding Out claim: [blank_start]Horizontalists[blank_end]: not an issue, since the Fed accommodates and no change in i [blank_start]Neoclassical Keynesians[blank_end]: a minor issue. While MB is constant, the banks expand lending as i increases, so not much of a change in i. [blank_start]Monetarists[blank_end]: a huge issue. Because both MB and MS are constant, the i effect is tremendous, which crowds out private I. Increase in G, equal decline in I. [Note, same conclusions as Classicals, but for different reasons, a M market feedback, not movement along PPF.]
• Monetarist
• Classicals
• Keynesians
• higher
• lower
• Horizontalists
• Neoclassical Keynesians
• Monetarists
• Neoclassical Keynesians
• Horizontalists
• Monetarists
• Classicals
• Monetarists
• Horizontalists
• Neoclassical Keynesians
• Classicals

### Question 4

Question
Detailed Analysis by each School: Monetarist Perspective The intuition behind Crowding Out comes from Classical Macro Classical Macro (we’re on the PPF): Can only expand G by cutting I Monetarist Macro: “We’re all Keynesians now.” Which means they acknowledge that Classical Capital Theory is [blank_start]wrong[blank_end], the interest rate is determined in the money market. It also means they recognize that demand, through AE and Keynesian-Cross model, plays a role in determining GDP (not “naturally” full employment). And they know we’re not on the PPF necessarily, U can exist. But they argue that while not constrained by physical constraints, the economy is ham-strung by monetary constraints. There is still [blank_start]scarcity[blank_end]. But for Monetarists, Vertical Sm, Ms fixed by [blank_start]Fed[blank_end]. Modern quantity theory of money: Fixed Ms, fixed velocity (institutionally given), Price level given exogenous to the model, together imply that y must be fixed, fiscal policy is [blank_start]powerless[blank_end]. The only thing that can cause a net shift in AE after considering crowding out is monetary policy. Equations (Sidebar): 1) [[blank_start]Hume[blank_end]] Equation of Exchange: Ms v =P y velocity a residual 2) [[blank_start]Keynes[blank_end]] Transactions demand for money: _ MDT = 1/v P y velocity assumed to be a constant, gives a theory of Md, causation runs from right to left, changes in v or P or y will change Mdt The demand for money is the [blank_start]dependent[blank_end] variable
• wrong
• right
• scarcity
• abundance
• greed
• Fed
• Individuals
• Government
• powerless
• effective
• Hume
• Keynes
• Keynes
• Hume
• dependent
• independent

### Question 5

Question
Equations (end of sidebar): 3) [[blank_start]Ricardo[blank_end]] Classical Quantity Theory of Money [of the effects of money on the [blank_start]economy[blank_end]] _ _ Ms v = P ys Since supply creates its own demand (Ricardo agreed with Say’s Law), Ys was determined on the supply side of the economy and was a constant. Where v is assumed to be constant and given, and ys is assumed to be determined on the real side of the economy (PC, economy is on its PPF). Ricardo (circa 1817) did this first (he was classical, labor theory of value not perfect competition). Here Money is a veil thrown over real relations (a transparent curtain), any change in the Ms has no real-world effect since Ys is independent of the amount of (credit-) money. Implication is that any change in Ms will only change P level, it will only cause inflation. The Ms is the [blank_start]independent[blank_end] or explanatory variable 4) Modern Quantity Theory of Money (Monetarists) [theory of effects of money on economy] _ _ Ms v = P YDemanded so Keynes was right to say changes in Ms cause changes in [blank_start]GDP[blank_end] demanded But, corollary: _ _ _ _ Ms v = P YDemanded implies YDemanded is also a constant. Money matters, and money is all that matters. Given constant v, given P level, any change in Ms can change Ys. Intuition, there is only enough money out there to fund a certain level of GDP. We can only “afford” to fund a certain level of GDP. However, ONLY a change in Ms can permit a change in Y (demanded). Money is powerful, and it is all-powerful. They conclude that the Fed’s hands should be tied, it should have no discretion and should have to follow a money-growth rule such as that the money supply is allowed to grow 3%/year to allow for real growth plus mild inflation.
• Ricardo
• Hume
• Keynes
• Monetarists
• economy
• individual
• independent
• dependent
• GDP
• Investment

### Question 6

Question
Mechanics of Crowding Out: Monetarists A) [blank_start]Direct[blank_end] Effect of any change (originating in M market, I(i), or AE) Standard 3-sector model, reading the model left to right B) [blank_start]Feedback[blank_end] Effect through money market (MDT) (jump back to M market & read 3-sector model left to right again: [for Monetarists, double arrows indicate stronger impact. How far does y fall? There is FULL CROWDING OUT, since Ms is [blank_start]fixed[blank_end], y cannot change from the fiscal policy initiative, the economy returns to its original position. The Fed constrains the economy, and as in charge. _ _ _ _ Ms v = P YD which implies YD is also a constant. Notice: |△G| = |-△I| The net change in GDP is [blank_start]zero[blank_end]. The induced change in [blank_start]investment[blank_end] is equal in magnitude and opposite in direction from the original change in government expenditure. Monetarist position is that the economy absolutely can’t grow unless there’s an [blank_start]increase[blank_end] in the Ms. But they also believe the Fed sits on a [blank_start]fixed[blank_end] nominal Ms when the economy is trying to grow. And want to constrain the Fed to let Ms grow at a steady rate, and only at a steady rate.
• Direct
• Indirect
• Feedback
• Feedback
• Direct
• Indirect
• fixed
• changing
• zero
• changing
• investment
• consumption
• saving
• taxes
• increase
• decrease
• fixed
• changing

### Question 7

Question
Mechanics of Crowding Out: Neocl Keynesian Response A) Direct Effect – same as for [blank_start]Monetarists[blank_end] B) Feedback Effect through money market (MDT): same as for [blank_start]Monetarists[blank_end]. BUT The magnitude of the resultant change in i is [blank_start]small[blank_end], so the change in I is small, so the change in AE does not return to the initial AE. How come? Because notice, for K’ns, the Ms does change. If the interest rate rises, banks will make more loans. So therefore the quantity of money does not prevent GDP from rising, it only constrains it a little bit. This is a minor mitigating feedback, who cares. There is [blank_start]PARTIAL[blank_end] CROWDING OUT. The net change in y is in the same direction as the direct effect. What’s the point? This is a minor mitigating feedback effect, relevant for an intermediate macro course, why bother with it at the intro level? For Keynesians, banks play a role [blank_start]independent[blank_end] of the Fed in providing liquidity or transactions money for the economy. That must be why we actually did have economic growth in the United States before 1913 when the Fed was created. Otherwise it is a puzzle.
• Monetarists
• Keynesians
• Horizontalists
• Classicals
• Monetarists
• Keynesians
• Classicals
• Horizontalists
• small
• huge
• PARTIAL
• FULL
• independent
• dependent

### Question 8

Question
Mechanics of Crowding Out: Horizontalists = Post Keynesians (Keynesian-Cross response) A) [blank_start]Same[blank_end] Direct Effect B) Feedback Effect through money market (MDT): Same as for [blank_start]Monetarists[blank_end] BUT, notice that if the Fed accommodates economic growth and mild inflation by adjusting the monetary base (MB), then MB depends on y. So y,  MB, (i) stays fixed. Therefore I is [blank_start]fixed[blank_end], as is A, and AE and y. The direct effect is the full effect. There is [blank_start]ZERO[blank_end] CROWDING OUT. The net change in y is exactly the same as the direct effect. “Crowding out” is an intellectual exercise, not a real-world problem. It has political content, the Classical perspective’s worry about government getting too big and hurting private enterprise. Historically the Fed has accommodated economic growth, it has not sat on a fixed nominal MB and told the Congress and the private sector.
• Same
• Different
• Monetarists
• Classicals
• fixed
• changing
• ZERO
• FULL
• PARTIAL

### Question 9

Question
Both Neocl Keynesians and Monetarists only “discover” crowding out by assuming that the monetary base is fixed. M’t: Ms = Mb * 1/rrr Mb fixed by Fed rrr fixed by Fed Therefore the Ms is fixed by the [blank_start]Fed[blank_end], and only Fed decisions can change Ms and y K’n: Ms = Mb * 1/(rrr+xr) Mb fixed by Fed rrr fixed by Fed xr variable, controlled by banks Therefore Ms will change as the incentive to hold [blank_start]xr[blank_end] changes (change in (i)). Therefore endogenous market forces (higher (i) causes lower xr) can causes changes in Ms by banks that at least partly respond to and accommodate economic growth. Both Monetarists and Keynesians form part of a common paradigm in assuming that the Fed [blank_start]obstructs[blank_end] economic growth by sitting on a fixed nominal Mb despite increases in the transactions demand for money. They assume what they claim to prove.
• Fed
• Government
• xr
• rrr
• rr
• obstructs
• accommodates

### Question 10

Question
Horizontalist/Post Keynesian/Keynesian-Cross: i = i^ Horizontalsts: Ms = Mb * 1/(rrr+xr) Mb not fixed, Fed accommodates by changing Mb Fed targets i^, provides liquidity following Fed-Treasury Accord rrr fixed by Fed xr variable, controlled by banks The Sm is [blank_start]horizontal[blank_end] at i^, and the Fed changes the Mb in response to changes in Y. The only reason that M’ts and K’ns conclude that there is any crowding out at all is because they assume a recalcitrant, obstructionist Fed that sits on a fixed nominal Ms despite the economy’s efforts to grow. Historically the Fed has accommodated economic growth. Its maintained behavior has been to accommodate mild inflation as well. It has been discretionary policy to intervene and raise the interest rate to fight [blank_start]inflation[blank_end] or to slow down an “overheated” economy or to affect the exchange rate. [blank_start]Normal[blank_end] Fed behavior has not been to sit on a fixed nominal Mb or Ms.
• horizontal
• vertical
• diagonal
• inflation
• deflation
• Normal
• Abnormal

### Question 11

Question
Foreign Exchange Markets Exchange-rate determination The [blank_start]exchange[blank_end] rate is the price of the dollar in terms of some other currency. The exchange rate is the cost of the dollar, the value of the dollar, the worth of the dollar,the purchasing power of the dollar in terms of other currencies. Rise in e, rise in purchasing power of the dollar. This is the money-of-account function of our currency. [blank_start]Appreciation[blank_end]: e rises [blank_start]Depreciation[blank_end]: e falls
• Appreciation
• Depreciation
• Depreciation
• Appreciation
• exchange
• interest
• discount

### Question 12

Question
Fixed Exchange-rate systems: 1) 19th century Europe, Gold Standard, British currency (pound) preeminent unit of account. Fell apart during & after WWI, restored by mid-20s most of Europe, fell apart again early 1930s during Great Depression. Gold served as [blank_start]international[blank_end] means of payment between nations. 2) Beginning at the tail end of WWII, 1944-1970 world economy, dollar (\$)-exchange standard under Bretton Woods). The \$ was pegged to gold (guaranteeing \$32/oz. of gold), and all other currencies were pegged to the dollar. Dollars served as international means of payment between nations. [blank_start]Revaluation[blank_end]: e rises (government announce a new “par value” for its currency) [blank_start]Devaluation[blank_end]: e lower (government announces a new lower “par value” for its currency)
• international
• national
• Revaluation
• Devaluation
• Devaluation
• Revaluation

### Question 13

Question
Balance of Payments: Current Account having to do with transactions that only matter [blank_start]now[blank_end], deficit or surplus has to do with NX plus net inflow of unilateral transfers BALANCE OF TRADE: (BOT) Merchandise Account [manufactured goods] Services (tourism, outsourcing of labor services, etc.) Together, BOT=NX Deficit on BOT means BOT = NX < 0 [blank_start]Unilateral[blank_end] transfers (immigrants send some of their earnings home, US foreign aid, or private philanthropy, e.g., Red Cross)
• now
• in the future
• in the past
• Unilateral
• Account

### Question 14

Question
Balance of Payments: Capital Account having to do with [blank_start]asset[blank_end] transactions, viz., some kind of real or financial investment, with expected return flows later (e.g., profits earned). Surplus on capital account is net capital inflow (deficit is net capital outflow) Inflow or outflow of funds (or capital goods) intended for real or financial investment (designated to earn a return, whether profits or interest) Capital inflow: financial money or K goods [blank_start]enter[blank_end] the US: Foreigners buy US T-bills Honda builds a factory in Maryland Foreigners buy stocks on NYSE Foreigners lend US manufacturers money Japanese citizens invest in California real estate Capital outflow: financial investments or K goods [blank_start]leave[blank_end] the US: US companies run away late 1970s, take the factory and move it to Thailand US pensions funds invest financially in Latin America Foreign companies based in US send profits back overseas (repatriation of profits) US companies invest abroad (e.g., Chrysler in Mexico)
• asset
• liabilities
• unilateral
• enter
• leave
• leave
• enter

### Question 15

Question
Balance of Payments: BOP Sum of the two: any deficit or surplus on the [blank_start]current[blank_end] account plus any deficit or surplus on the capital account There is an endogenous tendency for the current account and capital account to balance out. E.g., a company imports Brazilian shoes, and borrows from a Brazilian bank to finance the shoe production. That is simultaneous going to cause more of a deficit (higher imports) on the current account, and more of a surplus on the capital account (higher capital inflow), so the two tend to balance. If BOP it is not in balance, market forces will tend to push the [blank_start]exchange[blank_end] rate (e) away from its current position. Balance of Payments: Treasury Secretary determines US exchange-rate policy Fed (our Central Bank) executes Treasury policy Fed can buy and sell foreign currencies it holds (actually, foreign government bonds denominated in that country’s currency) to help balance a BOP that is temporarily out of whack. The exchange rate the Fed targets is set by the Treasury, since exchange-rate decisions are made by the Executive branch (president + cabinet).
• current
• past
• future
• exchange
• interest
• discount

### Question 16

Question
Foreign Currency Market or Foreign Exchange Market as vs. (Domestic) Money Market Market where e determined has q of \$ on horizontal axis. This is a [blank_start]flow[blank_end] concept, so many per unit of time. So many dollars exchanging for some other (foreign) currency. So many dollars trading on foreign currency markets. The total numbers of dollars in existence does not change, dollars are “[blank_start]conserved[blank_end]” since whoever is selling the dollars, someone else is buying them. Money market: determines i. The horizontal axis is the Ms. This is a [blank_start]stock[blank_end], not a [blank_start]flow[blank_end]. It is the [blank_start]total[blank_end] quantity of Mb and credit-money in existence. q\$ is often referred to as the “volume of foreign-exchange transactions” or the “volume in foreign currency markets,” it’s the [blank_start]quantity[blank_end] of dollars exchanging for foreign currencies. q\$ could be [blank_start]low[blank_end] relative to Ms (for instance if foreign trade is small relative to GDP in that large country, like Canada or the US), or it could be high relative to Ms (e.g., if tourism is 90% of GDP as in Bermuda for instance). A change in q\$ does not change the [blank_start]Ms[blank_end], it just affects how often that Ms changes hands across national borders.
• flow
• stock
• conserved
• converted
• changing
• stock
• flow
• flow
• stock
• total
• partial
• quantity
• quality
• low
• high
• Ms
• Mb
• MDT

### Question 17

Question
Rule #1: In the money market, certain players are on certain sides of the market: [blank_start]SM[blank_end]: Fed, banks [blank_start]DM[blank_end]: households, business, Congress, rich financiers In the foreign currency market, which side of the market you are on depends on your behavior: what you do, not who you are S\$: [blank_start]IM[blank_end], K [blank_start]outflow[blank_end] (have \$, move out of \$) D\$: [blank_start]EX[blank_end], K [blank_start]inflow[blank_end] (have foreign currency, move into \$) Rule #2: Do you have \$ or need \$? If have \$, must be selling \$; if need \$, must be buying \$ Shift in D\$ because people (foreigners or Americans holding foreign currency) move into dollars, “buy dollars” to a greater or lesser extent. Notice, you can buy more or less dollars. And to demand \$ means you’re not in \$ now, you’re in some other currency and want to get into \$ more or less. Shift in S\$ because people (Americans or foreigners holding US currency) move out of dollars into some other currency to a greater or lesser extent. Dump “dollars.” Notice, you can dump more or less dollars. And to supply \$ means you are in \$ now, but want to get into a different currency instead. if you have \$, you must be Supplying \$. If you need \$ because what you have is a different currency, you must be Demanding \$.
• SM
• DM
• DM
• SM
• IM
• EX
• NX
• outflow
• inflow
• EX
• IM
• NX
• inflow
• outflow

### Question 18

Question
Rules for shifting D\$ and S\$: Determination of D\$ shifts: RULE # 1) There are two sources of D\$: [blank_start]EX[blank_end] : US workers who make export goods are paid in dollars, foreigners who want our goods have to move into dollars (D\$) before they can buy them K [blank_start]Inflow[blank_end]: those holding foreign currencies want to buy \$-denominated assets, like stocks, bonds, money-market accounts, real estate, capital goods. Move into US currency to send purchasing power into the US. RULE # 2) Starting out in a foreign currency means you will demand dollars. Rule # 3) D\$ reflects a demand for \$-denominated goods, services or assets. Someone who is holding a foreign currency wants to [blank_start]buy[blank_end] US goods or some form of US wealth (land, buildings, stocks, bonds, etc.) The counterparts of these rules for S\$: RULE # 1) S\$ has two sources: [blank_start]IM[blank_end]: If we import French clothes. French workers are paid in French euros, so if US consumers want to buy clothes made in France, the clothing importer has to move out of dollars and into euros to buy the clothes. This shifts the S\$ out. K [blank_start]outflow[blank_end]: Those holding dollars or \$-denominated assets want to move into assets denominated in a foreign currency, they have to dump \$ and buy that foreign currency and buy the foreign asset. RULE # 2) If you start out in dollars, the only thing you can do in the foreign-currency market is to supply dollars (dump dollars) to move into another currency RULE # 3) S\$ reflects dumping dollars, a demand for Yen-denominated goods or assets (denominated in any foreign currency). You have dollars, move out of dollars into a foreign currency
• EX
• IM
• NX
• Inflow
• Outflow
• sell
• IM
• EX
• NX
• outflow
• inflow

### Question 19

Question
If the e is rising, as in 1979-81 the US \$ rose 80%, then Industry: Exporters cannot [blank_start]sell[blank_end] their products (the P of the \$, and therefore the price of their goods in foreign currencies, has risen, so US exports are more expensive). The \$ costs more. This hurt US exporters. US companies that compete with imports cannot sell their products because the \$ is worth more, so US consumers buy more imports and fewer domestic goods, so US car manufacturers in the 1980s lost ground to Japanese and other S. Asian imports. It was estimated that for a comparable US car you had to pay \$1500 more, given how “overvalued” the dollars was. This hurts US business that competes with foreign imports. Finance: US bond-holders and bond traders [blank_start]love[blank_end] a rising \$, because it means that anyone who buys any US asset and sits on it (if you held dollars for 1 ½ years in 1980-1 you got an average 55% annual rate of return just because of the appreciation). Strengthening or appreciation of \$ means that this will attract an increased demand for US bonds, stocks, more deals are made, bond-holders get a higher price for their bonds (this makes them lots of profits) and they love it. Households: “The consumer” As purchaser of imports, likes a [blank_start]strong[blank_end] dollar “The worker" As working to stay alive, likes a [blank_start]weak[blank_end] dollar – because they get to keep their jobs Conclusion: Industrialists (and workers) hate an “overvalued” (“strong”) dollar, Financial interests (and those who are securely employed, as consumers) love a “strong” (“overvalued”) dollar. It is simple self-interest.
• sell
• improve
• love
• hate
• strong
• weak
• weak
• strong

### Question 20

Question
The importance of a stable exchange rate: Finance and Industry agree on [blank_start]stability[blank_end] While industrialists look forward to a [blank_start]drop[blank_end] in the exchange rate, and need one in order to compete and survive, this last reason gives financiers an added incentive to fight tooth and nail against such a depreciation even when the economic tide has turned against them. But industrialists often have to plan years ahead for supplies of raw materials, or for imported goods, even light manufacturing like shoes, things aren’t just supplied when you want, it takes time. Therefore they make 2-3 year contracts to guarantee delivery dates, prices, and protect themselves against exchange-rate fluctuations. However, if the exchange rate does [blank_start]fluctuate[blank_end], they may find themselves competing with companies that are in a much more profitable situation, simply because the US e has risen. So, industry likes the exchange rate to be [blank_start]stable[blank_end] and low. If the e is [blank_start]high[blank_end] or stable, perceived as not very likely to fall, this will attract foreign financial investment to a “safe haven.” This is a kind of liquidity preference, where there is less risk or uncertainty with \$-denominated assets than, for instance, peso-denominated assets for Mexicans in the early 1990s or early 1980s. So again, financial interests love to keep stable currencies, even if they are high, because this ensures even greater demand for their financial products. The financial sector does like an appreciating or rising currency, but does not like volatility and [blank_start]instability[blank_end]. So they do favor Fed [blank_start]intervention[blank_end] to keep the currency stable, or to make it rise. Therefore Fed plays a role in keeping the exchange rate [blank_start]stable[blank_end], even under the “floating” exchange rates since 1970 (i.e., exchange rate subject to market forces). We get “dirty” floats, or managed flexibility in foreign currency markets.
• stability
• drop
• fluctuate
• stable
• high
• instability
• intervention
• stable

### Question 21

Question
Fed currency swaps during financial crisis The Fed made 6-month deals with trading partners, primarily (80%) with Eurozone. To lend the \$ at a fixed agreed-upon exchange rate, and have it be paid back at a fixed agreed-upon exchange rate This was 1/3 of the total spending by the Fed between 2008-2010 [blank_start]Stability[blank_end] is very important in the macroeconomy – reducing uncertainty The currency swaps succeeded in avoiding speculative runs against, for instance, the Euro. The Fed wasn’t shoring up the euro, it was helping assure predictability in its exchange rate. Everyone benefited, except the speculators. Fed stabilization of currency markets Fed targets e* based on historic exchange rates chosen by the Treasury, and on the state of the economy and other macro policy goals. So even “floating” exchange rates are characterized by “dirty floats”, governments intervene to help assure exchange-rate stability. It is in business’s and financial-sector interest to have e-stability, as long as e is viable. Importers and exporters like to know e is pretty set for several years, since they have to plan 18 mos-2years ahead to get products delivered to stores (sent by slow boat) Fed Policy: The Fed can only enter the market, can cause the D\$ or S\$ to shift out. (it can’t tell people to [blank_start]leave[blank_end] the market, go away).
• Stability
• leave

### Question 22

Question
Suppose the Treasury/Fed target is below the market exchange rate. So if the exchange rate is temporarily overvalued, above the e^ targeted by the Fed, the Fed will shift [blank_start]out[blank_end] the S\$. Fed will use \$’s to [blank_start]buy[blank_end] foreign currencies, “sell the \$”, really buy government issues (short-term debts) denominated in foreign currencies, e.g., British consoles Suppose the Fed target is above the market exchange rate. So, if the e is temporarily undervalued, below the e^ targeted by the Fed, Fed has to raise q\$ (only thing it can do) and raise e, therefore the Fed will Shift [blank_start]out[blank_end] D\$. By using its foreign currency holdings to buy dollars (sell foreign government bonds, convert yen to \$, buy US T-bills or just hold the \$’s) Is this a viable proposition? If it’s short-term stabilization, yes. Notice what the Fed’s doing, it’s buying the \$ when it’s [blank_start]cheap[blank_end], and it sells the \$ when the \$ is expensive (the e is too high). Therefore the Fed makes money on this stabilization activity. What if the exchange rate is always too low? Can the Fed keep using foreign currencies to “prop up” the dollar (to buy more dollars and keep e high)? No. It will run out of foreign currency. This is when we hear about pressure on the currency to depreciate, or in a fixed exchange-rate system, to devalue, to come down. Pressure on the Fed to “let the dollar fall”, let the exchange rate drop to what the market says it should be.
• out
• out
• cheap

### Question 23

Question
1993 Mexican currency crisis Before talking to the US Treasury, the Fed spent \$9 B to prop up the Mexican peso Clinton Treasury Dept and Congress said ok to \$20 B for “stabilization” Since the US government had sufficiently deep pockets, they could finance the Central Bank’s (Fed’s) continued efforts to prop up the Mexican [blank_start]currency[blank_end]. 2008 Financial Crisis Fed created Central Bank [blank_start]Liquidity[blank_end] Swap Lines (CBLS), permitting primarily Europe to borrow dollars at a fixed exchange-rate to use to buy their own currencies and support their exchange rate. This helped eliminate speculation that those currencies would fall, and speculative pressure on those countries. The Hong Kong dollar had fallen 40% in 1997 after the government tried to shore up its currency, and ran out of foreign-currency holdings. Arguably the 40% overshot the mark because of all the speculation. The Fed’s CBLS prevented the same from happening to Europe.
• currency
• Liquidity

### Question 24

Question
Neoclassical Synthesis wanted to restore important role for AS-AD analysis based on PC /Imperfect Competition underpinnings rather than Strategic Competition. Synthesis of Keynes and the Classics: Keynes – demand determines GDP, Ys responds passively (AS [blank_start]horizontal[blank_end]) Classics – supply conditions (PPF) determines GDP, demand (money is the only demand story they had) is a veil thrown over real relations Synthesis: You’re both right some of the time, we’re (we synthesizers) are right most of the time, standard business-cycle experience This includes Monetarists & Neoclassical Keynesians We want to have AS and AD both be important for determining GDP, so we use a P,y axis. The Neoclassical Synthesis adds Imperfect Competition to Perfect Competition Adds Keynesian and Monetarist versions to Classical Macro (Supply-side economics or New Classical economics) But Neoclassical Macro Synthesis rests on the Neoclassical Micro Synthesis (including both Perfect Competition and Imperfect Competition) we’ve talked about all semester. So the Neoclassical Macro Synthesis brings back 5 crucial hidden assumptions [blank_start]rejected[blank_end] by Strategic Competition and the Keynesian-Cross theory: * Owner/Operator * Short-run profit maximization * Diminishing returns, i.e., crowded factory model and scarcity * Workers sell Labor-services on the labor market * Atomistic Rational Individual with no needs or who’s independently wealthy who maximize utility (translation: L-leisure tradeoff)
• horizontal
• vertical
• rejected
• accepted

### Question 25

Question
Neoclassical Synthesis of Keynes and Classics: Neoclassical Keynesian range of AS: [No more Strategic Competition] Keynes said supply was [blank_start]passive[blank_end], we have said nothing about the P level so far in the Keynesian-Cross model. So if supply is passive, how do we show that in a P-y diagram? P must be [blank_start]given[blank_end], since we don’t know what it is. AS must be [blank_start]horizontal[blank_end] at that given P level, since companies respond passively to customer demand. Demand ends up determining y, supply is passive. This is called the Keynesian range of the AS diagram Note, GDP is relatively low, there is tremendous [blank_start]excess[blank_end] capacity in the economy, adjusting ys by adding shifts and overtime is feasible
• passive
• given
• horizontal
• excess

### Question 26

Question
Classical Range of AS: SIDEBAR: 1) Equation of Exchange: Ms v P y velocity a residual 2) Transactions demand for money: MDT = 1/v P y velocity assumed to be a constant, gives a theory of Md, causation runs from right to left, changes in v or P or y will change Mdt 3) Classical Quantity Theory of Money _ _ Ms v = P ys > Where v is assumed to be constant and given, and ys is assumed to be determined on the real side of the economy, ys is [blank_start]fixed[blank_end] (PC, economy is on its PPF). Ricardo (circa 1817) did this first (he was classical, labor theory of value not perfect competition). Here Money is a veil thrown over real relations, any change in the Ms has no real-world effect since Ys is [blank_start]independent[blank_end] of the amount of (credit-) money. Demand plays no role in determining output, supply is [blank_start]determinant[blank_end]. Note that in the Classical Quantity Theory, ys is a [blank_start]constant[blank_end]. Implication is that any change in Ms will only change P level, it will only cause [blank_start]inflation[blank_end]. 4) Modern Quantity Theory of Money (Monetarists) Ms v = P YD Given constant v, given P level, any change in Ms can change Ys. However, ONLY a change in Ms can permit a change in Y (demanded). Money is powerful, and it is all-powerful. They conclude that the Fed’s hands should be tied, it should have no discretion and should have to follow a money-growth rule such as that the money supply is allowed to grow 3%/year to allow for real growth plus mild inflation. END SIDEBAR From the sidebar, in the Classical approach ys is a constant. That is, potential GDP is actual GDP, markets clear, there is no market failure, and we are at [blank_start]maximum[blank_end] output.
• fixed
• independent
• determinant
• constant
• inflation
• maximum

### Question 27

Question
Why is AS upward sloping in the Neoclassical Synthesis Range?: Diminishing Returns Diminishing returns: higher Ys requires higher costs as companies [blank_start]crowd[blank_end] the factory, so price level rises if the economy is below full employment, why isn’t there excess capacity, why need to [blank_start]crowd[blank_end] the factory? [SC – constant costs] if price level is going up, wouldn’t their input costs also be rising, so wouldn’t they just supply their original quantities they chose given real input costs? Then you’re on the [blank_start]vertical[blank_end] Classical AS schedule. Or, if your prices are rising and your input prices are also rising, then you would only increase output if prices are accelerating upward, there is accelerating inflation. This is not a new (P, Y) point on an upward-sloping AS schedule. It’s the vertical AS Classicals draw. - This story does not work as a theory of upward-sloping AS, it’s consistent with [blank_start]vertical[blank_end] AS. Real GDP is determined by the intersection of DL = MPL and SL determined by the Labor-Leisure trade-off.
• crowd
• crowd
• vertical
• vertical

### Question 28

Question
Why is AS upward sloping in the Neoclassical Synthesis Range?: Bottlenecks Bottlenecks: As the economy expands and Ys rises, some sectors hit [blank_start]full[blank_end] employment (or shortages of crucial scarce resources) before others, so their costs rise and P [blank_start]rises[blank_end] OK, but not an alternative theory of Ys. This is more a real-world description than a theory of supply, it’s a description of short-term price changes. Keynes knew any bottlenecks would be [blank_start]temporary[blank_end], and as supplies were able to increase, he said, P would fall back to where it was before. This rise in relative P indicates need to reallocate resources to the sectors facing shortages and bottlenecks, once that happens P should drop back down Besides, the cause of higher Y is not the [blank_start]inflation[blank_end], it’s vice versa: the rising demand causes [blank_start]higher[blank_end] output and also causes some price increase, not because of costs but because of inelastic demand (price-gouging, charging more for limited stuff This does not explain Y supplied, it explains [blank_start]prices[blank_end]. What about sectors left behind in the expansion, e.g., excess supply of steelworkers. Wouldn’t they have lower wages and bring prices down?
• full
• rises
• temporary
• inflation
• higher
• prices

### Question 29

Question
Why is AS upward sloping in the Neoclassical Synthesis Range?: Input Contracts Input Contracts: a) Input prices are [blank_start]fixed[blank_end] by contract while output prices are flexible. b) And in order for companies to expand Ys, they require a higher profit margin (profits/\$ sales). c) So output prices rise, giving them the higher profit margin, as Ys [blank_start]rises[blank_end]. Suggests there are only [blank_start]raw[blank_end] materials and final products, what about intermediate goods (capital goods): one company’s output price is another company’s input price. Plus, why suddenly do companies need rising profit margins to expand? Under profit maximization, any positive profit is inducement to expand (so MC = MB in equilibrium). Now suddenly the same profits for the next unit of output is no good, you have to earn continually increasing profits as you expand or you’ll refuse to supply output (MB-MC keeps increasing). This is an extortion or accelerating-greed theory of profits.)
• fixed
• rises
• raw

### Question 30

Question
Why is AS upward sloping in the Neoclassical Synthesis Range? Monetarist: Money Illusion, Really Money(-of-account) Illusion ASSUME: 1)Almost PC, 2) As the economy changes, on average prices change faster than [blank_start]wages[blank_end]. (almost PC: some institutional rigidities prevent W’s from changing as fast as prices can). (PC Labor market assumptions about DL and SL, real W/P on axis.) 3) In an expansion: ASSUME: rising demand causes rising prices and therefore some rise in [blank_start]wages[blank_end] to a lesser extent 4) Monetarists envision labor market as initially at [blank_start]full[blank_end] employment before the expansion. 5) Imperfect information for workers: they’re fooled by [blank_start]inflation[blank_end], focus on nominal variables and interpret them as if they were real changes. Companies however have perfect information. STORY: So in an economic expansion, prices rise: Firms: See real wage fall so willing to earn lower MPL(=W/P) so hire more workers and [blank_start]crowd[blank_end] their factories Workers: [Fooled by wage [blank_start]inflation[blank_end].] See rising nominal W and think it will mean more purchasing power (higher real wage) and increase Ls and give up leisure. Don’t immediately notice that prices have also risen, and even faster than the wage. Workers choose to increase their hours at work Combined: higher LD, LS, Ys increases Notice: If we were talking about an economic contraction for Monetarists, and prices fell more than wages, workers would quit their jobs because they’d see wages being cut and they’d choose leisure. The recession is voluntary choices to leave work. This is not a theory of involuntary unemployment. Notice, we have to assume the rising prices, which is what we’re trying to prove. What happened to initial SC argument that dropping inventories leads to increased Ys without a price effect? Typically taught at beginning of intro macro, then switched for this assumption, without motivation. This is assuming what we’re trying to prove. Why asymmetry? Are workers stupid and companies smart? “Fooling” hypothesis. Response – companies have better ways of estimating inflation, so they have [blank_start]information[blank_end] (again, almost PC, not quite perfect information). ? How long will it take workers to catch on? Response – at low inflation rates, the real-income effects are [blank_start]small[blank_end] so it could take a while. ? But these are obsessive workers who calculate how many labor-hours vs. leisure are worth it given small changes in the wage rate. Suddenly they don’t obsess? Inconsistent. The BLS reports on inflation every month, wouldn’t they notice? Wouldn’t it take at most a few months to figure this out? Yet this is a story designed to explain business-cycle expansions which last 1½ –10 years. Doesn’t make sense unless there is accelerating inflation and workers are continually fooled. Wouldn’t workers notice even this pattern and demand accelerating wage increases? Analysis rests on irrational workers or uninformed workers. Especially since as consumers they continue to be rational, yet it’s the same people.
• wages
• wages
• full
• inflation
• crowd
• inflation
• information
• small

### Question 31

Question
Why is AS upward sloping in the Neoclassical Synthesis Range?: Rational Expectations Rational Expectations [New Classical]: Workers are not fooled by [blank_start]inflation[blank_end] any more than companies are Then AS is not upward sloping in the short run, it is [blank_start]vertical[blank_end]. The short run picture is the old Classical long run. This is a return to the Classical macro model Keynes criticized.
• inflation
• vertical

Question
• fixed
• workers
• leisure
• employers
• recessions
• unemployed
• unions
• deflation
• fall
• change

### Question 33

Question
Why is AS upward sloping in the Neoclassical Synthesis Range?: Long Run Need to link change in P level with change in output supplied (ys ) M’t: workers no longer fooled by [blank_start]inflation[blank_end], insist on higher real wage if going to work more hours. Companies can’t afford to pay higher real wage. Equilibrium returns to original position K’n: labor contracts are renegotiated to increase N to [blank_start]equilibrium[blank_end] level. Return to equilibrium real wage and L-services hired. So in the long run we’re back in the Classical world. How is this a synthesis of Keynes and the Classics? Where is the possibility of long-run depression, like the 1930s, on the supply side? Absent.
• inflation
• equilibrium

### Question 34

Question
Shifting Aggregate Supply 1) Anything that will shift PPF outward, will shift AS [blank_start]outward[blank_end] Anything that will shift PPF inward will shift AS [blank_start]inward[blank_end]. [PPF was about potential right? AS is supposed to be about actual. No one worries about the distinction here.] 2) Anything that decreases company costs and raises profitability will shift AS [blank_start]out[blank_end]: Anything causing a decrease in unit costs, rise in unit , will cause AS to SHIFT OUT. So, what’s behind AS? Anything behind PPF: Technology, institutional context, resources (quantity and quality of LF, K, land) Labor productivity And anything behind Supply of labor: extent of preferences for leisure over labor This is called Growth Theory – The theory of what causes shifts in AS Other kinds of supply are not aggregate supply: Notice, the money supply affects demand (change in Ms changes i, therefore I, AE, YD) Also, changes in the supply of dollars affects demand (changes the exchange rate, therefore NX, AE, YD.
• outward
• inward
• inward
• outward
• out
• in

### Question 35

Question
NOTE: where there is a shift in AS, y changes more in the lr, P changes more in lr Short run vs. Long run AS What we’ve been discussing is AS representing business-cycle movements (expansion, recession). This is called the short run Micro - Short Run means K stock is [blank_start]fixed[blank_end], L varies (1-10 years) Long Run means K can [blank_start]vary[blank_end], plant size can change, and there may be decreasing returns to scale due to coordination failure (company too big to manage effectively) (longer than 1-10 years) Macro - Short Run means over the course of a business cycle (2-9 years) Or really, over the expansion phase (1 ½ -8 years). Long run means [blank_start]trends[blank_end], from one business-cycle to the next (e.g., one peak to the next peak or one trough to the next trough. (more than 2-9 years, 18-20 years): Trend Long run, what happens to shape of AS? M’t,: Workers are no longer fooled, they quit their jobs, we return to [blank_start]equilibrium[blank_end] in PC labor market K’n: Wage contracts are renegotiated to reflect realistic levels, we [blank_start]return[blank_end] to PC labor market equilibrium So it’s a Classical Macro world, AS is [blank_start]vertical[blank_end], return of PC, in particular, the PC labor market with L-Leisure trade-off and diminishing returns due to factory crowding
• fixed
• vary
• trends
• equilibrium
• return
• vertical

### Question 36

Question
Why is AS upward sloping in the Short Run? Monetarists: Workers are fooled by [blank_start]inflation[blank_end] Keynesian: Wages are [blank_start]fixed[blank_end] by labor contract Why AS is Vertical in the Long Run? Monetarists: Workers catch on to the [blank_start]inflation[blank_end], require that real wages rise if they are to stay in new jobs, leave LF when employers say no. So in the cyclical expansion, workers had increased Ls beyond the “natural” rate, beyond what we have been calling full employment. The recession level of U is the natural rate of U. Workers being fooled effectively pushes the economy beyond its potential. Keynesian: Labor contracts can be [blank_start]renegotiated[blank_end]. Since the cause of involuntary U was real wages being too high, employers can negotiate for nominal wage cuts, and this restores full employment. Note that the boom level of U is the long-run rate of U or “natural” rate, the recession is below potential.
• inflation
• fixed
• inflation
• renegotiated

### Question 37

Question
Aggregate Demand: Keynes: Keynesian-Cross/SC, Post-Keynesians - Demand is determinant of GDP [[blank_start]vertical[blank_end] AD] Neoclassical Synthesis/Almost PC, IC: Neoclassical Keynesian, Monetarist, Neoclassical short run - Need both Supply and [blank_start]Demand[blank_end] in the short run or over the business cycle to find GDP (in long run or for trend growth rate, supply is determinant) Classical/PC: Supply-Side, Rational Expectations, Neoclassical long run - Supply is determinant of GDP [[blank_start]Horizontal[blank_end] AD, or slope irrelevant] Keynes said [blank_start]demand[blank_end] determines Y, Classicals said [blank_start]supply[blank_end] determines Y, the Neoclassical Synthesis says you need [blank_start]both[blank_end] AS and AD to determine Y, it comes out of their interaction, and is mediated by the price level. Derive AD: Why does rise in P level cause a drop in YD? 1) *Transaction demand for money:  P,  MDT so  i (given fixed MB by Fed), lower I along I(i), lower AE, lower YDemanded. Note that we reinterpret equilibrium Y on the AE diagram as YDemanded, not actual GDP since we have a separate theory of supply (AS). 2) International: Assume 1) fixed e, 2) any  US price level is faster than abroad, then  PUS  gets passed abroad. [PUS rises faster than PROW [rest of the world]] Implications:  EX to other countries (our stuff is more expensive) and IM look more attractive (since our stuff is more expensive) so IM, so  NX, and AE, and YDemanded . 3) Real-wealth effect or real-balances effect or Pigou effect: increase P level so decreases real monetary balances—M/P, that is, the money households have in checking & savings accounts decrease real wealth of households decrease Ca, AE, YDemanded
• vertical
• Demand
• Horizontal
• demand
• supply
• both

Question
• vertical
• accommodates
• fixed
• downward
• inflation

### Question 39

Question
Shifts in AD Anything that causes AE to shift up causes AD to shift [blank_start]up[blank_end] [shift in AD is new equilibrium in AE] Only exception: a change in P level is already on the graph, so changes in P, while causing a shift in AE, will not shift AD, they will move us along AD What causes shifts in AS? [blank_start]PPF[blank_end] shifts Helpful Hint – If shift SM Also note, shifts in the supply of money can be handled intuitively by thinking about the consequent changes in Ms and therefore AE (same direction), because higher Ms means lower i.
• up
• PPF

### Question 40

Question
Empirical Phillips Study: A. W. Phillips 1958, empirical study of US 20th century, plotted W growth against U and found that nominal wages tended to [blank_start]rise[blank_end] more steeply as U fell. But the relationship was like a hyperbola. And he asked, what is the macroeconomic theory behind this? The Neoclassical Synthesis developed an answer: Wage growth tends to echo [blank_start]price[blank_end] growth, since both workers and companies are concerned with real wages (W/P) over the long haul. So they derived a [blank_start]downward[blank_end]-sloping Analytical Phillips Curve from shifting AD and moping along AS, which then moves the economy along the Phillips Curve. The short run or business-cycle AS shape explains the downward-sloping and curved shape of the Phillips relationship—it is a business-cycle description So as AD shifts out and we move to the right and up along AS The Phillips Curve mirrors AS and we move back and up along the Phillips Curve The Phillips Curve is just another way of drawing [blank_start]AS[blank_end], to put U on the horizontal axis instead of Y Colander finesses the problem by saying that in the expansion, there are constant outwards shifts in AD. So there is demand-pull inflation. He knows that the Neoclassical Synthesis jump from AS to Ph Curve is analytically flawed, so he makes the case that way.
• rise
• price
• downward
• AS

### Question 41

Question
Is this involuntary U on the analytical Phillips Curve? Monetarist – it is voluntary leaving of the labor force as P and W falls, and workers quit to choose [blank_start]leisure[blank_end] at the lower nominal W Keynesian – it is [blank_start]involuntary[blank_end] for the individual, caused by the fixed nominal W set by union contract. However, the union itself was chosen by these individuals, fought for against opposition, the union wage increase was demanded by these workers. Are they stupid collectively? Wouldn’t they notice that this caused recessions and rethink? Historically recessions were [blank_start]worse[blank_end] before widespread unionization, and have been worse since unions have been increasingly decertified. The Phillips Curve, like the AS schedule, implies that there will be no involuntary unemployment above the natural rate of U if only wages can be flexible downward. Because for Keynesians this would mean that the labor contract is renegotiated, and AS is vertical, so Phillips would be vertical.
• leisure
• involuntary
• worse

### Question 42

Question
Long Run AS is [blank_start]vertical[blank_end], Phillips is mirror of AS, so Phillips Schedule is [blank_start]vertical[blank_end]. We are back in a Classical world, there is no [blank_start]depression[blank_end], the only possible U is structural+frictional = natural, the natural rate of U [Some economists speak of the NAIRU (non-accelerating-inflation rate of unemployment).] Notice, in the long run, what is the Keynesian explanation for the vertical Phillips Schedule? Wages are [blank_start]renegotiated[blank_end]. If there’s a recession, and AD falls, this will mean lowers prices and over time wages will be cut through renegotiations and we will return to full employment.
• vertical
• vertical
• depression
• renegotiated

### Question 43

Question
Colander on cost-push vs. demand-pull inflation (Neoclassical vein, letting AS shift (cost-push) or AD shift (demand-pull) Cost-push inflation (ongoing prevalence of inward shifts in AS) Cost-push inflation involves any upward pressure on [blank_start]price[blank_end] caused by a change in supply-side conditions, or by initiatives from the supply side Examples of cost-push inflation Anything that causes PPF or AS to shift [blank_start]in[blank_end] Notice that when there is a [blank_start]decline[blank_end] in the real aggregate income being negotiated over (a decline in the size of the pie), if everyone tries to defend their habitual real income levels (W, profits) by passing on the higher cost, we will just have an ongoing wage-price spiral, perhaps even accelerating inflation as recent inflation rates get built into the process, and everyone demands more than last year’s inflation rate just to cover their real income. At issue is a conflict over the distribution of income. Notice, then the real issue with accelerating inflation is the underlying [blank_start]decline[blank_end] in real national income and everyone trying to recoup lost income. The only way to stop the inflation without hurting GDP is to address the income redistribution issues directly through an INCOMES POLICY (more below) or through targeted programs to help those hardest hit by the lost income. Modern efforts to fight deterioration in PPF or AS is Governmental investment in infrastructure Demand-pull inflation (caused by chronic outward shifts in AD) Anything that causes AD to shift [blank_start]out[blank_end] causes higher prices Standard efforts to counteract such inflation is to [blank_start]contract[blank_end] AD (e.g., tight M policy or higher T or lower G) would end up reducing the inflation rate. These are called austerity policies when invoked by the IMF in developing countries facing exchange-rate problems.
• price
• in
• decline
• decline
• out
• contract

### Similar

Economic Growth
Macroeconomics year 1
Chapter 16: The objectives and instruments of macroeconomic policy
Dictionary Macrostructure
Chapter 15: Introducing macroeconomics
Monopolistic Competition VS Oligopoly
Exchange rates
Economic summary December 2014
Fundamental Economic Theories & Concepts
MACRO ECONOMICS
IS-LM model