Macro economics analysis

Interpret a₂ and a₃ (i.e., what do they measure) and why are they so important in terms of measuring the impact of the Great Recession on consumption.

Why is a₃ larger than a₂?

Derive an expression for the aggregate expenditure curve and graph it on your exam sheet labeling this initial equilibrium output as point A. Also, add this point A to your consumption function.  Show all work.

Draw an aggregate demand and an aggregate supply curve in the right hand graph on your exam sheet identifying this initial point as point A.

NOTE:  We are holding the price level fixed at 100 in this problem. Also, note that you that you cannot derive an expression for the aggregate demand curve, just draw it with a negative slope going through point A.

We now let G rise to 1000 as the Federal Government (fiscal policy) authorities are not happy with the level of GDP. Solve for the new equilibrium output and label as point B on all three of your diagrams. Please be sure to label your diagrams completely and show all work.

What is the government spending multiplier in this problem and what does this government spending multiplier depend on?

Suppose, that instead of holding prices fixed as we did in this problem, that prices were perfectly flexible, as in a classical world. Discuss, do not show, how your graphs would be different. Also, comment on what would happen to the government multiplier under the assumption of perfectly flexible prices.

NOTE:  This question is worth 10 points.

Upload your Part 1 exam sheet here. Correct and completely labeled diagrams are worth 30 points.

Pretend you are in charge of conducting monetary policy at the New York Fed and you have the following initial conditions.

Initial Conditions

rr/D = .10

C = 900 b

D = 1800 b

ER = 0

M = C + D 

Given the above information (show all work on your exam sheet):

i) Calculate the MB.

ii) Calculate the money multiplier (mm).

iii) What is the money supply (use MS = mm x MB)?

 

***MAKE A RESERVE MARKET GRAPH

If R_d = 240 – 30 i_ff, given the information above, what is the market clearing federal funds rate? Assume that this is the target for the federal funds rate. Show all work.

In the space on your exam sheet, draw a reserve market diagram depicting exactly what is going on here! Label the equilibrium point as point A.

Suppose that due to whatever reason, reserve demand changes and you forecast the reserve demand to now be R_d = 270 – 30 i_ff. In order to keep the federal funds rate at target, what must the open market desk do? Be specific and show this development in your picture on your exam sheet (label the new equilibrium as point B).

Suppose the alternative, that the open market desk does nothing different, that is, they hold the amount of reserves constant. What happens in the reserve market? What is the market clearing fed funds rate now? Label this development, that is, the new equilibrium as point C. Be sure to show all work.

Upload your exam sheet for Part 2 here. A correct and completely labeled diagram is worth 10 points.

Let’s go back to the fall of 2008 when we were at the height of the financial crisis. Pretend you are steering the cruise ship and your goal is to keep interest rates steady in the money market.

For simplicity, we hold the price level fixed at 1 and assume that inflationary expectations are fixed at 2%.

Initial Conditions before the fall of 2008

mm = money multiplier = 1.6

MB = monetary base = 3000

Money Demand

M_d = P X [ a₀ + .5 (Y) – 200 (i) ]

M_d = 1 X [ 2600 + .5 (5600) – 200 (i) ]

Solve for the money market clearing rate of interest (show your work on your exam sheet). Now draw a money market diagram labeling this initial equilibrium in the money market as point A on your exam sheet.
MAKE A MONEY MARKEY GRAPH!!!****

We now experience a shock to the money multiplier so that the new value of the money multiplier is now 0.8. Given that we are in the fall of 2008, what caused such a shock to the money multiplier?

In addition to the shock to the money multiplier as in Question 15, we experience two more shocks that influence the money demand curve: The new, money demand curve is now equal to:

M_d = 1 X [ 2900 + .5 (5400) – 200 (i) ]

Explain why we would expect this to happen to the money demand function during the fall of 2008. Be sure to discuss both of the shocks to money demand.