Question: What role does the IS curve play

> Throughout much of the 2010–2015 period, the fed funds rate was substantially lower than what a Taylor rule for monetary policy would seem to indicate. Why?

> What is the fundamental source of transition dynamics in our AS/AD framework? Why does the economy take several periods before returning to its steady state following a shock?

> What are some examples of shocks that shift the AD curve? What about the AS curve?

> How does a central bank influence economic activity in the short run?

> Do the following production functions exhibit increasing, constant, or decreasing returns to scale in K and L? (Assume

> Why is the relationship between output and the real interest rate called the “IS curve”?

> Why does the IS curve slope downward?

> What is a balance sheet? What is net worth?

> A Monetary History of the United States, 1867 to 1960, by Milton Friedman and Anna Schwartz, is a classic study of monetary policy and was published in 1963. Read the interview with Anna Schwartz available at www.minneapolisfed.org/publications/ the- reg

> What are some recent shocks that have hit the macroeconomy?

> How do the long- run model and the short- run model fit together? What is the purpose of each model?

> Explain some of the costs of hyperinflations. If they are so costly to an economy, why do they occur?

> The poorest countries in the world have a per capita income of about $600 today. We can reasonably assume that it is nearly impossible to live on an income below half this level (below $300). Per capita income in the United States in 2015 was about $51,0

> Make one change to the basic combined model that we studied in this appendix: let the production function for output be Yt = AtK1/4 t L3/4 yt . That is, we’ve reduced the exponent on capital and raised it on labor to preserve constant returns to objects.

> Growth in the combined Solow- Romer model is faster than growth in the Romer model. In what sense is this true? Why is it true?

> Suppose xt =(1.04)t and yt =(1.02)t. Calculate the growth rate of zt in each of the following cases: (a) z = xy (b) z = x/y (c) z = y/x (d) z = x1/2y1/2 (e) z =(x/y)2 (f) z = x-1/3y2/3

> Consider the following (made- up) statistics for some economies. Assume the exponent on capital is 1/3 and that the labor composition is unchanged. For each economy, compute the growth rate of TFP. (a) A European economy: gY/L = 0.03, gK/L = 0.03. (b) A

> Suppose the economy has a natural rate of unemployment of 5%. (a) Suppose short- run output over the next 4 years is +1%, 0%, −1%, and −2%. According to Okun’s law, what unemployment rates would we expect to see in this economy? (b) Consider another ec

> Japanese GDP in 2012 was 468 trillion yen (U.S. GDP was $16.2 trillion). The exchange rate in 2012 was 79.8 yen per dollar. Contrary to China and India, however, Japan had higher prices than the United States: the price level in Japan (converted to dolla

> The Fisher equation relates real (R) and nominal (i) interest rates to the rate of inflation (

> Suppose the Fed announces today that it is lowering the fed funds rate by 50 “basis points” (that is, by half a percentage point). Using the IS- MP diagram, explain what happens to economic activity in the short run. What is the economics underlying the

> Suppose velocity is constant, the growth rate of real GDP is 3% per year, and the growth rate of money is 5% per year. Calculate the long- run rate of inflation according to the quantity theory in each of the following cases: (a) What is the rate of inf

> Suppose scientists discover a new way to extract oil from deposits that were previously thought to be unrecoverable. The extra supply of oil leads oil prices to decline by $5 per barrel. Explain the effect on wages, the employment- population ratio, and

> Suppose the parameters of the IS curve are

> Consider the following simple monetary policy rule: Rt −

> Using the FRED database, download a graph of the share of income paid to labor for the nonfarm business sector of the U.S. economy, back to 1947. (For an introduction to FRED, see the case study “The FRED Database” in Chapter 2 on page 34.) (a) Display t

> Compute the average annual growth rate of per capita GDP in each of the cases below. The levels are provided for 1980 and 2014, measured in constant 2011 dollars.11 1980 2014 United States 29,288 51,958 Canada 24,716 43,376 France 22,557 37,360 Unit

> Create a new table that contains only the last three columns of the table in exercise 5. This time, instead of reporting the numbers relative to the U.S. value, report the inverse of these numbers. For example, you should have found that per capita GDP i

> When and where did sustained economic growth first begin? How much inequality in per capita income was there throughout the countries of the world a thousand years ago? How much is there today?

> Why are capital requirements an important part of any reform to improve the functioning of the financial system?

> Describe the Fed’s balance sheet in “normal” times. How did it change during the financial crisis? Why?

> What is deflation, and what problems does deflation pose for the macro economy? How does deflation interact with the zero lower bound for nominal interest rates?

> Why is the Great Recession best understood in the IS/ MP– Phillips curve framework instead of the AS/AD framework?

> What are financial frictions, and what role do such frictions play in the financial crisis? How does a financial friction enter the IS/MP diagram and the AS/AD framework?

> Why are inflation expectations so important to modern monetary policy? What are several ways that central banks try to manage inflation expectations?

> Why do inflation- output loops appear counterclockwise?

> Why does the AD curve slope downward? Why does the AS curve slope upward? How is the AS/AD graph like a standard supply- and- demand diagram? How is it different?

> Plot the following scenarios for per capita GDP on a ratio scale. Assume that per capita GDP in the year 2015 is equal to $10,000. You should not need a calculator or computer program. Use the Rule of 70 to label the value of per capita GDP on the graph

> How is a monetary policy rule helpful for understanding U.S. monetary policy?

> Why do central banks often exercise monetary policy by targeting an interest rate rather than by setting particular levels of the money supply?

> What policy change did Paul Volcker implement, and how did it affect interest rates, output, and inflation over time?

> What is the Phillips curve? What role does it play in the short- run model? Explain the role played by each term in the equation for the Phillips curve.

> What is the relevance of Milton Friedman’s phrase “long and variable lags” to this chapter?

> What is the economic justification for the sticky inflation assumption? What role does this assumption play in the short- run model?

> Figure 12.1 presents a summary of the short- run model. Explain each step in this diagram. Figure 12.1: FIGURE 12.1 The Structure of the Short-Run Model MP IS Phillips curve curve curve Change in inflation, Nominal Real Shor

> What are three insights you gained from studying the micro foundations of the IS curve?

> For the development of the rest of the short- run model in the next two chapters, we could just present the equation for the IS curve,

> What are some examples of changes in the economy that would lead to movements along the IS curve? What are some changes that would shift the IS curve?

> Suppose your retirement account has a balance today of $25,000 and you are 20 years old. If you are invested in a diversified portfolio of stocks, you might hope that the historical return of about 6% continues into the future. Consider how the balance i

> What is leverage, and why is it so important in understanding the financial crisis?

> How severe was the Great Recession? What pieces of economic data would you cite to support your answer?

> Why is Okun’s law a useful rule of thumb to keep in mind when analyzing our short- run model?

> How can you “see” the Phillips curve operating in the graph of inflation in Figure 9.5? Figure 9.5: FIGURE 9.5 Inflation in the United States, 1960-2015 Percent 14 12 10 4 2 1960 1965 1970

> Before the latest financial crisis and recession, when was the largest recession of the past 50 years, and what was the cumulative loss in output over the course of the slowdown?

> Why do we measure short- run output

> How can we understand the Great Inflation of the 1970s? Does the government budget constraint help?

> What is the government budget constraint? How does it help us understand the causes of high inflation?

> What are the costs of inflation, and how can these costs be avoided?

> Suppose xt grows at 2% per year and yt grows at 5% per year, with x0 = 2 and y0 = 1. Calculate the numerical values of zt for t = 0, t = 1, t = 2, t = 10, t = 17, and t = 35 for the following cases: (a) z = x (b) z = y (c) z = x3/4y1/4

> What is the difference between a real interest rate and a nominal interest rate? What is the intuition behind the Fisher equation?

> Why do economists think the classical dichotomy holds in the long run?

> A concise summary of the quantity theory of money is that inflation occurs because of too much money chasing too few goods. Explain.

> Give some examples of economic questions where the concept of present discounted value would be useful.

> Is the unemployment rate in Europe today higher or lower than in the United States? What about hours worked per person? What are some possible explanations for the differences?

> What is the difference between the natural rate of unemployment and cyclical unemployment? How are these related to structural and frictional unemployment?

> What are some examples of changes in the economy that would cause the labor supply curve to shift? What might shift the labor demand curve? How do these changes affect the wage rate and the employment- population ratio?

> What is the definition of the unemployment rate?

> What explains the general rise in the employment- population ratio in the United States? By how much did the ratio decline around the last recession? How many jobs does this represent?

> Why is growth accounting useful?

> Suppose k, l, and m grow at constant rates given by

> The growth rate of output in the Romer model is

> Explain how nonrivalry leads to increasing returns in the two key production functions of the Romer model.

> Suppose a friend of yours decides to write a novel. Explain how ideas and objects are involved in this process. Where do nonrivalry and increasing returns play a role? What happens if the novel is sold at marginal cost?

> What is nonrivalry, and how does it lead to increasing returns? In your answer, what role does the standard replication argument play? Is national defense rivalrous or nonrivalrous?

> What is the principle of transition dynamics? Why does the Solow model lead to this principle, and why is it useful?

> The Solow model implies that differences in total factor productivity are even more important in explaining differences in income across countries than the production model of Chapter 4 suggested. Why?

> What is the solution of the Solow model for consumption per person in the steady state, c∗ ≡ C ∗/L∗? How does each parameter in the solution affect c*, and why?

> What is the mechanism in the Solow model that generates growth? Why is this an appealing mechanism? Why does it fail to deliver economic growth in the long run?

> Look back at Table 4.3. Why do such large differences in capital lead to relatively small differences in predicted GDP across countries? Table 4.3: TABLE 4.3 The Model's Prediction for Per Capita GDP (U.S. = 1) Predicted per

> How does the national income identity show up in the ice cream model?

> In exercise 6, the correct way to compute the average growth rate is to apply equation (3.9). An alternative— but incorrect— way is to take the percentage change divided by the number of years: for example, 1/T × yT − y0/y0 . Compute the growth rates wit

> What is the purpose of macroeconomic models? How can a model of ice cream production be used to explain 50-fold income differences across countries?

> What is the purpose of macroeconomic models? How can a model of ice cream production be used to explain 50-fold income differences across countries?

> Why are the Rule of 70 and the ratio scale useful tools? How do they work together?

> What are the key ingredients of an economic model, and why are models useful?

> What is an equilibrium in the ice cream model?

> How much richer is the typical 40- year- old today than the typical 40- year- old 35 years ago in the United States? What about in South Korea or China?

> Now let the production function for output be Yt = AtKa tL1−a yt . That is, we’ve made the exponent on capital a parameter (

> Consider the combined model studied in this appendix. Suppose the economy begins on a balanced growth path in the year 2000. Then in 2030, the depreciation rate

> Suppose we observe the following growth rates in various economies. Discuss whether or not each economy is on its balanced growth path. (a) A European economy: gY/L = 0.03, gK/L = 0.03. (b) A Latin American economy: gY/L = 0.02, gK/L = 0.01. (c) An Asian

> What is the principle of transition dynamics in the combined Solow- Romer model?

> Indian GDP in 2014 was 119 trillion rupees, while U.S. GDP was $16.5 trillion. The exchange rate in 2014 was 61.0 rupees per dollar. India turns out to have lower prices than the United States (this is true more generally for poor countries): the price l

> Write a couple of paragraphs about the state of the economy in the euro area over the past several years. What has happened to inflation, real GDP growth, and unemployment? What about a key policy interest rate set by the European Central Bank (ECB)? [Hi

> The Federal Open Market Committee (FOMC) is the formal name of the group chaired by Yellen, Bernanke, and others that meets every 6 weeks or so to set monetary policy in the United States. Immediately after the meeting, the FOMC issues a statement consis

> Suppose the economy starts with GDP at potential, the real interest rate and the marginal product of capital both equal to 3 percent, and a stable inflation rate of 2 percent. A mild financial crisis hits that raises the financial friction from zero to 2

> (a) Why does the AD curve slope downward? (b) If the AD curve were more steeply sloped, how would the economy respond differently to aggregate demand shocks (shocks to

> (a) Why does the AS curve slope upward? (b) If the AS curve were more steeply sloped, how would the economy respond differently to aggregate demand shocks (shocks to

> In the late 1990s and early 2000s, inflation was actually negative in Japan (look back at Figure 13.19). This question asks you to explore a change in policy to achieve a higher inflation rate. Consider an economy that begins with output at potential and

> Suppose the European and Japanese economies succumb to a recession and reduce their demand for U.S. goods for several years. Using the AS/AD framework, explain the macroeconomic consequences of this shock, both immediately and over time.

> Between 2006 and the middle of 2008, oil prices rose sharply—from around $60 to more than $140 per barrel. By the end of 2008, however, oil prices had fallen even more sharply, to just over $40 per barrel. Think of these events as two separate shocks. (a