Part 1: 1. Consider the following model: i) C =1500 +mpc(Y –tY) ii) I=800 iii) G=500 iv) X-M = 500 –mpi (Y) where: ...

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Part 1 - Consider the following model

April 14, 2018

Part 1:

1. Consider the following model:

i) C =1500 +mpc(Y –tY)

ii) I=800

iii) G=500

iv) X-M = 500 –mpi (Y)

where:

t=the (flat) tax rate

mpc= the marginal propensity to consume

mpi= the marginal propensity to import

supposemps = .80 t =.25 mpi=.2

Given the information above, solve for the equilibrium output:

A) Y*=3300

B) Y* = 5500

C) Y* =1500

D) Y* =1800

2. We know that the formula for the (government) spending multiplier is 1/(1-mpc(1-t) + mpi). The value of the government spending multiplier in this problem is: round to 2 decimal places.

A) 1.33

B) 2.55

C) 3.33

D) 1.67

3. When we discussed the multiplier we discussed the impact effect. For example, suppose that G increases by 100 to 600 and we assume, as we often do, that firms match the increase in demand by increasing Y by 100. In round two, this is an increase in income of 100 to consumers. We will trace out exactly where this 100 increase in income goes in the second round. Recall, there are three leakages to address (via taxes, imports and savings).

Given that t=.25, we know that .25 of every dollar increase in gross income is a leakage due to taxes. Since the increase in income is $100, we know the leakage due to taxes is:

A) $25

B) $100

C) $75

D) 25 cents

4. Given that mpi=.2, we know that .2 of every dollar increase in gross income is a leakage due to imports. Since the increase in income is $100, we know the leakage due to imports is:

A) $100

B) $80

C) $20

D) 20 cents

5. Given that the MPC= .8 we know that .2 of every dollar increase in gross income is saved. Since the increase in income is $100, we know the leakage due to savings is:

A) $100

B)$80

C)$20

D) 20 cents

6. To find out how much consumption increases we need to take the increase in income ($100) and subtract out the leakages. So take the $100 and subtract your answers from #3, #4 and #5 above. When income increase by $100, consumption increases by:

A0 $100

B) $25

C) $20

D) $35

7. What would happen to the multiplier if the mpi rises to .25? Round to 2 decimal places

A) the new multiplier is 1.54

B) the new multiplier is 1.89

C) The new multiplier is .65

D) the new multiplier is .37

8. What would happen to the size of the leakage if the mpi rises to .25?

A) this would reduce the size of leakage

B) This would increase the size of the leakage

9. In this question we are going to dig deeper into the Taylor Rule and its variants (modifications).

Federal Reserve data from October 1, 2001:

Potential GDP growth y* = 1.7%

Actual GDP growth y^A=2.0%

Inflation PCE (actual inglation) pie^A= 2.6%

Effective Federal Funds rate= .07%

As Taylor assumed, we assume the equilibrium real rate of interest r* = 2% and the optimal inflation rate, the target inflation rate pie* is also equal to 2%

The standard (original) Taylor rule formula:

IffTR= r* + pieA+0.5[pieA-pie*] + 0.5[yA-y*]

Using the standard taylor rule from above and using the data provided what is the federal funds rate implied by the standard taylor rule?

A)2.04%

B)1.56%

C)3.33%

D)5.05%

10. According to the actual federal funds rate (use the effective federal funds rate provided above for 2011-10-01), is Fed being hawkish or dovish?

A)hawkish

B)dovish

11. Now consider the modified version of the Taylor using the unemployment gap instead of the GDP gap just like we did in the lectures. Also, we will use the PCE core rate of inflation instead of overall inflation like you used above – the Fed arguably care more about core inflation than overall inflation

Modified Taylor Rule Formula:

IffTR= r* + pieA+0.5[pieA-pie*] + 9-125)[URA-NAIRU]

Additional needed data from Federal Reserve data from October 1, 2011:

Unemployement rate URA = 8.7%

NAIRU = 5.5%

Inflation PCE core (actual inflation) pieA = 1.8%

Now what is the federal funds rate implied by the modified Taylor Rule above?

A) -.45

B) -.30

C) 0.45

D) 0.30

12. According to the actual federal funds rate, is the Fed being hawkish or dovish?

A)hawkish

B)dovish

Part 2: True and False

13 Unemployment benefits are an example of fiscal policy

14. according to r4icardian Equivalence in a strict sense, the tax multiplier is zero.

15. When looking at the GDP data from quarter 3 of 2012, gov’t purchases accounted for a larger share of the economy than investment expenditures did.

16. According to one of the lectures featuring a pie chard on fe3deral gov’t expenditures, transfer payments went from about 25% of total expenditures in the 1960s to over 46% of total expenditures in 2010

17. As of 2010, interest payments on federal debt exceeded 10% of total expenditures

18. We argued that the tax revenue that the federal gov’t collects is pro-cyclical, that is, when economic activity is growing so is tax revenue. An example of this is the new economy when tax revenue increased along with the economic growth.

19. If aggregate expenditures exceeded income than inventories will rise and firms will eventually lay off workers

20.We argued that cutting the corporate income tax will have supply side effects in that cutting the corporate income tax can potentially increase the pace of technological change with the implication being the aggregate supply will shift to the right.

21. According to the Laffer curve, increases in tax rates always result in less tax revenue

22. One reason that tax revenue may fall when tax rates are increased is due to tax evasion, that is, the higher the tax rate, the higher the probability of the tax evasion and thus, lower tax revenue,. The example I used was when Canada quadrupled the tax rate on cigarettes Canadian citizens sought out to buy illegally smuggled in US cigarettes to evade the tax on Canadian cigarettes.

23 The term voodoo economics is a term used by the proponents of supply side economics trying to explain to its critics that lower tax rates will result in higher tax revenue

24. Barro is considered to be a supply side economist which is consistent with his idea that we should eliminate the corporate income tax

25. According to the table depicting the effective tax rate on capital for 2007, the only country that has a higher effective tax rate on capital is Greece

26. According to our discussion of supply side economics, there are positive aggregate demand side effects and positive supply side effects, similar to what happened during the new economy

27. We argued that the tax multiplier is higher in absolute value than the gov’t spending multiplier

28. The more the Fed accommodates shocks to money demand, the large the (gov’t) spending multiplier

29. According to the Congressional Budget Office(CBO), the stimulus package worked in terms of creating jobs, lowering unemployment, and raising GDP

30. Spending by local gov’ts to stimulate or slow down their local economies is an example of fiscal policy

31. When talking about tax multipliers using tax rates instead of the more simple lump sum taxes, we argued that social security tax cuts resulted in a higher tax multiplier

32. when we add the marginal propensity to import to our model, the spending multiplier falls. In fact, the higher the marginal propensity to import, the smaller the spending multiplier all else constant.

33. According to the “We are all Keynesians Now” article, the labor secretary at that time wanted the unemployment rate to fall down to 3%

34. The misery index in 1980 exceeded 25

35. The mid to late 1970s was the ‘heyday’ of Keynesian economics in the US economy

36Keynes believed that it was the responsibility of the gov’t to use its powers to increase production income and jobs

37 Consistent with his thought on spending heavily, Keynes was known as an excellent tipper.

38 The steeper the SRAS curve, the steeper the short-run Phillips curve

39 If the long-run aggregate supply curve is vertical so is the long-run Phillips curve.

40 Friedman and Phelps agreed that there is a trade off between unemployment and inflation

41If actual inflation is lower than expected inflation, then the actual real wage is higher than the expected real wage. This being the case firms will lay off workers

42 According to the Taylor Rule described in the lectures, if the Fed is getting an A+ then the federal funds rate should be set at 5%

43. According to the Taylor principle, if actual inflation rises by 1% over target inflation then the Fed should raise the federal funds rate by 2% to make sure that the real federal funds rate rises which is referred to as “leaning against the wind”

44. If the actual federal funds rate is higher than the funds rate implied by the Taylor rule, then we say that the central bank is hawkish

45 If actual inflation rises 1% above target and the central bank raises the actual funds rate by 1% then according to the Taylor rule, the central bank is being hawkish

46 According to the Taylor Rule, the Greenspan Fed was hawkish during the new economy years

47 According to the Taylor rule, the Greenspan fed was hawkish during the job-less recovery as well as the job-loss recovery

48 One way to explain the apparent tradeoff between inflation and unemployment during the 1960s expected inflation was consistently higher than the actual inflation implying that firms would be willing to hire more workers given this difference between expected and actual inflation. The result therefore would be higher inflation and lower unemployment, consistent with the facts during the 1960s

49 We argued that the modified version of the Taylor rule during the jobloss recovery following the 1990-1991 recession explained Greenspan and the fed’s behavior much better than the original Taylor Rule

50 According to the Phillips curve analysis, if expected inflation is equal to actual inflation then we are at NAIRU. However, if actual inflation is higher than expected then the actual unemployment rate will be higher than that associated with NAIRU

51 If firms and workers had perfect foresight as to inflation so that actual = expected inflation at all times, then the Phillips curve would be vertical and thus, there would be no trade between unemployment and inflation, even in the short run

52 we argued that a federal funds rate target of 4% is consistent with the stance of monetary policy being neutral as in neither tight nor loose










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