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ECON 104 Final: Final Exam EQ

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27 Jul 2016
School
George Mason University
Department
Economics
Course
ECON 104
Professor
Rustici/ Gillespie

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Document Summary

The role of monetary policy by milton freidman. Keynes believed that fiscal policy, rather than monetary, was the answer to economic issues. The great depression disproved this theory: most people believed that during the depression the u. s. government had practiced expansionary monetary policy and that it had failed. In fact, the government had practiced deflationary monetary policy allowing the quantity of money to fall by 1/3 and it was so powerful that it worsened the. Now, the consensus has moved back to being in favor of monetary policy. What monetary policy cannot do: peg interest rates for more than very limited periods. The fed will buy bonds to keep interest rates down, which will last less than a year. Then, the monetary growth will stimulate spending, raise income, and raise prices, which will return interest rates to their original level: peg the rate of unemployment for more than very limited periods.

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Related Questions

1. Why Niall Ferguson thought that the expansionary fiscal policy (or government deficit) could produce crowding-out effect? You can explain by using the IS-LM model or you can use the logic of loanable funds theory

Answer: Ferguson believes that an increase in the government deficit could produce a crowding-out-effect. First, I will touch base on fiscal policy. Well, what is it? Basically, it adjusts the nation’s spending amount which increases the economy’s deficit to close a recessionary gap, which therefore increases the the demand for loans, meaning people want to borrow money. An increase in demand for loans leads to an increase in interest rates. Higher interest rates lead to a decrease in investment and interest-sensitive consumer spending, so both C and I decrease. That’s what the crowding-out-effect is, the decrease in investment due to higher interest rates.

>in Deficit = >in Demand for Loans = >in interest rates =

The government speeds up the economy by deficit spending, they crowd out consumers and investors with high interest rates. So what this means is that the government is attempting to help the economy but it is actually hurting the economy. The reason why I think Ferguson believes this is because of what he says in his debate at the New York Review of Books, that “you can’t be both a monetarist and a Keynesian simultaneously—at least I can’t see how you can, because if the aim of the monetarist policy is to keep interest rates down, to keep liquidity high, the effect of the Keynesian policy must be to drive interest rates up.” He continues on in the interview to say that the Fed has minted out a fresh $1.75 billion in bonds and that no one is going to buy them. Driving up bonds will increase interest rates which increases mortgage rates which is why he basically doesn’t agree with the Keynesian theory.

2. Why Paul Krugman thinks that Niall Ferguson was wrong and thought that government deficit could not produce a crowding-out effect? In other words, please explain Krugman's Liquidity trap .

Answer: To start I think Krugman believes that the Fiscal policy is effective. It is effective when the Liquidity-Money (LM) curve is horizontal. It creates the crowding in effect. The supply of money is constant so it creates money demanded to be interest inelastic, meaning it doesn’t change. So if the government wishes to stimulate the economy, it leaves interest rates at a constant rate, and an increase in investment and saving, therefore helping the economy close the gap on a recession. There is an indifference between money and bonds so this makes fiscal policy effective. So then we get into a monetary expansion, meaning we have an increase in the money supply. Well with the liquidity trap, we get the case that the investment-savings (IS) curve is horizontal. So when the government increases the money supply, investment responds to rapidly changing interest rates, which would decrease the money demanded, making monetary policy effective. But the liquidity trap becomes apparent because interest rates cannot fall below zero percent. This is when monetary policy would become ineffective because interest rates aren’t declining meaning investment wouldn’t continue. Krugman in his blog basically argues this. He states “Most spectacularly, IS-LM turns out to be very useful for thinking about extreme conditions like the present, in which private demand has fallen so far that the economy remains depressed even at a zero interest rate.” He sums up his argument for the liquidity trap and explains his logic behind the investment-savings, liquidity-money curve, and that is why he disagrees with Ferguson.

3. In the discussion, other discussants such as George Soros and Robin Wells pointed out some interesting issues. Please provide at least one thing that you agree and one thing that you disagree. Discuss in details why you think so.

Answer: One thing I found interesting was George Soro’s point in the debate in the New York review of books. He states “The other feature is that the financial system collapsed of its own weight. That contradicted the prevailing view about financial markets, namely that they tend toward equilibrium, and that equilibrium is disturbed by extraneous forces, outside shocks. Those disturbances were supposed to occur in a random fashion. Markets were seen basically as self-correcting. That paradigm has proven to be false. So we are dealing not only with the collapse of a financial system, but also with the collapse of a worldview.” He continues to mention how Obama has 2 problems he has to face and how people who are viewing this crisis the same as the previous financial crisis, are making a huge mistake. To explain he states this: “But when you have a collapse of credit there’s only one source of credit that is still credible, and that’s the state: the Federal Reserve and the Treasury. Then you have actually to inject a lot more leverage and money into the economy; you have to print money as fast as you can, expand the balance sheet of the Federal Reserve, increase the national debt. And that is, in fact, what has been done, which is the right thing to do. But then once this policy is successful, you have to rein in the money supply as fast as you can.” I think Soro is agreeing with Krugman and the monetary policy of pumping money into the economy. It will raise the money supply which eventually is left for us to capitalize on supply and let our GDP. Now I find this interesting because he is also agreeing with Krugman’s IS-LM model, and later on, we come to find out that even Ferguson had come to an agreement with Krugman’s points, with the exception being that the United States was a powerhouse, and therefore the European Union would eventually see its downfall.

Please make comments to the answer of discussion I provided above(at least 300 words total). And you can start with "I agree with you on some points... But I disagree with you on some points".

1. Fiscal policy attempts to affect the level of overall spendingin the economy by changes in:
A) the interest rate.
B) the money supply.
C) banking regulations.
D) taxes and spending.


2. Economists have identified several consecutive months of fallingemployment and forecasts for the next few months are for more ofthe same. At what point in the business cycle is the economyapparently located?
A) recession
B) expansion
C) business cycle peak
D) business cycle trough


3. The onset of the Great Depression:
A) was not a shock to anyone since most economists predicted the“roaring 20s” were bound to end in disaster.
B) created a disagreement between the Hoover administration andconventional economists because Hoover wanted the government tointervene much more quickly than most others.
C) came as a considerable shock to the conventional wisdom ofeconomics at that time and opened the door for critiques ofmainstream thought by economists like JM Keynes.
D) was in 1918 at the end of World War I.


4. When economists measure economic growth, they often use:
A) the inflation rate.
B) the unemployment rate.
C) nominal GDP.
D) real GDP.


5. In a typical business cycle, the business cycle peak isimmediately followed by the:
A) recession.
B) business cycle trough.
C) expansion.
D) depression.


6. Suppose an economy experiences rising total output accompaniedby increasing employment, this is generally known as:
A) stagflation.
B) recession.
C) inflation.
D) expansion.


7. Controlling interest rates is an example of:
A) fiscal policy.
B) tax policy.
C) monetary policy.
D) exchange rate policy.


8. The alternation between recessions and expansions is known asthe:
A) unemployment rate.
B) long-run economic growth.
C) business cycle.
D) macroeconomy.


9. A recession in America is typically associated with:
A) a falling unemployment rate.
B) a decrease in the number of people living in poverty.
C) a decrease in the percentage of Americans with healthinsurance.
D) an increase in corporate profits.


10. The purpose of macroeconomic policy is to:
A) bring unemployment closer to the natural rate.
B) reduce the severity of recessions.
C) rein in excessively strong expansions.
D) bring unemployment closer to the natural rate and to reduce theseverity of recessions.


11. The trade balance is the difference between the value ofthe:
A) trade deficit and the budget deficit.
B) goods and services that one country sells to other countries andthe value of the goods and services it buys in return.
C) exchange rates of two countries that are engaged ininternational trade.
D) national debt and the foreign debt.


12. Increasing the total amount of available productive resourcesis the focus of __________.
A) macroeconomics
B) fiscal policy
C) monetary policy
D) microeconomics


13. The point on a business cycle when real GDP stops rising andbegins falling is a(n):
A) peak.
B) trough.
C) expansion.
D) recession.


14. During a recession, one will often observe:
A) aggregate output rising.
B) unemployment rates will be increasing while aggregate output isfalling.
C) employment rates will be rising.
D) zero unemployment rates.


15. Monetary policy involves:
A) changes in government spending.
B) changes in government tax receipts.
C) changes in the quantity of money.
D) changes in tax rates.


16. The trough of the business cycle:
A) comes right after the expansion phase.
B) comes before the recession phase.
C) is a temporary maximum level of real GDP.
D) is a temporary minimum level of real GDP.


17. Which one of the following statements about the U.S. economy isnot accurate?
A) Since the Second World War, aggregate output grew at a ratelower than the average annual growth rate of population.
B) Since the Second World War, aggregate output grew at a ratehigher than the average annual growth rate of population.
C) Since the Second World War, macroeconomic policy has helped makethe economy more stable.
D) Long-run growth per capita is the key to higher wages and arising standard of living.


18. An economic recovery is all of the following except:
A) economic growth of a sustained nature.
B) a short-run increase in aggregate production in aneconomy.
C) a time of increasing employment.
D) the end of the business cycle.


19. Which of the following would NOT be classified as amacroeconomic question?
A) How many people are employed in the economy as a whole?
B) What determines the overall level of prices in the economy as awhole?
C) What determines the overall trade in goods, services, andfinancial assets between the United States and the rest of theworld?
D) What determines the cost to a university or college of offeringa new course?


20. Which of the following statements regarding price level orinflation is correct?
A) Supply and demand can not explain why a particular good orservice becomes more expensive relative to other goods andservices.
B) Inflation affects only the more advanced countries whereas lessadvanced countries face deflation.
C) Prices of most goods and services remained stable during thegreat depression.
D) In general, when the economy is in recession and jobs are hardto find, inflation tends to fall.


21. If wages grew at a 5% rate last year and average prices grew ata 3% rate, then the average worker is:
A) better off.
B) worse off.
C) no better or worse off.
D) unaffected.


22. In an open economy:
A) the exchange rate is determined by the government.
B) specialization in activities with a comparative advantage is notpossible.
C) trade is only beneficial to the relatively larger economy.
D) there is trade in goods, services, or assets with othercountries.


23. Changes in government spending and taxes in an effort to changeoverall spending in an economy is:
A) fiscal policy.
B) monetary policy.
C) investment.
D) the stock market.


24. If an economy is open, this means that:
A) anyone can immigrate to the country.
B) trading with other countries makes up a portion of itseconomy.
C) it does not trade with other countries.
D) it will experience a drop in its real GDP.


25. Inflation is a situation where:
A) the average price level falls.
B) the average price level increases.
C) the average price level becomes negative.
D) the real price level falls.


26. The topics studied in macroeconomics include:
A) the price of a motorcycle.
B) the wages of engineers.
C) the average price level in the economy.
D) how much ice cream consumers buy.


27. A period of rising real GDP is a(n):
A) peak.
B) trough.
C) expansion.
D) recession.


28. The modern tools of macroeconomic policy are:
A) tax policy and antitrust policy.
B) fiscal policy and monetary policy.
C) monetary policy and exchange rate policy.
D) capital policy and labor policy.


29. A “rubber necking” traffic jam is an example of:
A) microeconomics in action.
B) individual behavior that has a large aggregate impact.
C) the paradox of thrift.
D) an outcome smaller than the sum of its parts.


30. The most painful consequence of a recession is:
A) rising unemployment.
B) increasing inflation.
C) increasing aggregate output.
D) higher interest rates.


31. Per capita economic growth is:
A) economic growth per unit of capital.
B) economic growth per person.
C) economic expansion over the business cycle.
D) sustained increase in aggregate output.


32. Keynesian economics stressed:
A) total spending.
B) the self-regulating power of free markets.
C) the long run.
D) that the Depression should run its course to bring down the highcost of living.


33. When an economy's overall production grows faster than itspopulation, this is referred to as:
A) long-run growth per capita.
B) an increase in nominal GDP.
C) deflation.
D) the paradox of thrift.


34. Fiscal policy attempts to affect the overall level of spendingin the economy through:
A) changes in the inflation rate.
B) changes in the quantity of money or the interest rate.
C) changes in tax policy or government spending.
D) discretionary regulation of profits and wages.


35. With regard to the aggregate price level, economists generallybelieve:
A) price stability is a desirable goal.
B) inflation is worse than deflation.
C) deflation is worse than inflation.
D) inflation actually benefits most retired people.


36. Recessions are periods when:
A) output rises.
B) the aggregate price level rises.
C) the unemployment rate is falling.
D) output and employment are falling.


37. Monetary policy attempts to affect the overall level ofspending in the economy by changes in:
A) taxes.
B) taxes and spending.
C) taxes and interest rates.
D) interest rates and the quantity of money.


38. The basic difference between an economic recession and economicdepression is that:
A) the latter is a shorter economic downturn than the former.
B) during recessions output falls faster than duringdepressions.
C) during depressions employment falls faster than duringrecessions.
D) the former is a longer economic downturn than the latter.


39. The central mission of modern macroeconomics is to prevent_____ from happening again.
A) recessions
B) inflation
C) deflation
D) anything like the Great Depression


40. Fiscal policy refers to:
A) the control of interest rates.
B) the control of government spending and taxations.
C) the control of the quantity of money.
D) the control of interest rates and of government spending.


TRUE or FALSE?

1. Real GDP can never be greater than potential GDP. 

2. When foreign countries experience an increase in income, this is likely to increase our GDP. 

3. The United States economy spends about as many months in recession as it spends in expansion. 

4. If individuals decrease their consumption spending then this is likely to reduce the growth rate of GDP, all else the same. 

5. Movements of real GDP around potential GDP are called the business cycle. 

6. If total government spending in a given year was $3.7 trillion, then all of this spending counted directly in GDP as part of the government spending (G) category. 

7. The last recession in the United States began in December of 2007. 

8. During a recession, the inflation rate tends to decline. 

9. Changes in spending that cause firms to change their level of production of goods/services are called supply shocks. 

10. All else the same, an increase in income in the United States leads to a decrease in our net exports. 

11. Since 1929 there have been 14 declared recessions in the United States. 

12. Total spending in the economy is equal to consumption + investment + government spending - net exports. 

13. During each recession, potential GDP falls. 

14. Percentage wise, the government collects more tax from individuals than it does from firms. 

15. During a recession, the Federal Reserve pursues contractionary monetary policy. 

16. During a recession, the Federal Reserve is most likely to sell government bonds to the public. 

17. Investment spending increases during periods of recession. 

18. Congress meets about every 6 - 8 weeks to discuss the performance of the economy and potential changes to fiscal policy. 

19. If there is more competition among firms, then the inflation rate will tend to increase. 

20.The demand for labor increases when the economy is in an expansionary phase. 

21. Total spending by the government is about 20% of GDP in the US economy. 

22. The unemployment rate decreases during periods of expansion. 

23. If oil prices increase by 20% then this is an example of a supply shock. 

24. When the Federal Reserve buys government bonds, interest rates are likely to fall. 

25. If Congress wanted to help the economy out of a recession, they would be most likely to reduce government spending and/or increase taxes. 

 

Falsenot in accordance with the fact or reality or actualityMore (Definitions, Synonyms, Translation)