Select two (2) of the following questions:
Problem 1
Suppose the economy is operating at potential GDP, something like was the case for the U.S. in mid-2018. The unemployment rate has reached historic lows, suggesting that the economy is at full employment. Now suppose that due to an economic slowdown in Europe, U.S. export sales decline.
Suppose potential GDP occurs where Y = $10,000 billion. Suppose that the marginal propensity to consume is 0.75. If we assume that both taxes and imports are given then the simple expenditure multiplier formula applies. Suppose exports fall by $100 billion. Use the multiplier formula to estimate the change in GDP. Suppose further that for every one percentage point that GDP falls below potential, the unemployment rate will rise by half of one percentage point. How much then will the unemployment rate rise due to the decrease in exports?
Problem 2
Problem 3:
Changes in the value of a nation’s currency affect the nation’s net exports, and thus GDP. How might this make a large country, like the U.S., more willing to adopt a flexible exchange rate regime than a small country, like Belgium?
Problem 4:
The Great Recession was the most serious economic downturn in U.S. history since the Great Depression. The recession began in December 2007. Interest rates at the time were very low, close to zero. Despite the American Recovery and Reinvestment Act of 2009, a nearly $800 billion fiscal stimulus, and an expansionary monetary policy, the economy is only now getting back to normal in 2015.
In retrospect, what set of macro policies, if anything, should we have conducted to achieve a better recovery? Show using the AD/AS model and explain your reasoning.
The U.S. experienced a shift in its unemployment rate from 4.6% in July 2001 to 5.9% by June 2002. This type of change in the unemployment rate can be attributed to a combination of factors, but it’s essential to distinguish between cyclical unemployment and changes in the natural rate of unemployment.
Cyclical unemployment is the result of economic fluctuations, specifically downturns in economic activity. During recessions, businesses cut back on production, leading to decreased demand for labor and increased unemployment. A change in the unemployment rate like the one observed during this period could indeed be influenced by cyclical factors, especially considering the economic slowdown during the early 2000s.
On the other hand, changes in the natural rate of unemployment are more structural and are influenced by long-term shifts in the economy. Factors such as technological advancements, changes in demographics, and alterations in the labor force participation rate can contribute to changes in the natural rate of unemployment. However, a one-year shift in the unemployment rate is less likely to be solely due to a change in the natural rate.
Given the relatively short time frame between July 2001 and June 2002, the observed increase in the unemployment rate is more likely a result of cyclical unemployment associated with the broader economic environment. The dot-com bubble burst during that period, causing a recession and subsequent layoffs, which aligns with the characteristics of cyclical unemployment.
The Great Recession, which began in December 2007, was a significant economic downturn in U.S. history. Despite efforts such as the American Recovery and Reinvestment Act of 2009 and expansionary monetary policies, the recovery was slow and gradual. To understand what macro policies could have led to a better recovery, we can analyze the situation using the AD/AS model.
In the AD/AS model, the aggregate demand (AD) curve represents the total demand for goods and services in the economy, while the aggregate supply (AS) curve represents the total supply of goods and services. The intersection of these curves determines the equilibrium output level and price level.
In this case, the recession led to a decrease in aggregate demand, shifting the AD curve to the left. To achieve a better recovery, a combination of fiscal and monetary policies could have been implemented. On the fiscal side, the government could have increased its spending even further, targeting key sectors like infrastructure, which has a multiplier effect on the economy. By doing so, the AD curve would shift to the right, boosting demand and output.
Monetary policy could have also been more aggressive. The central bank could have further lowered interest rates and implemented quantitative easing to encourage borrowing and spending. By reducing the cost of borrowing, businesses and consumers would have been more inclined to invest and spend, which stimulates economic activity and shifts the AD curve to the right.
In summary, a more robust fiscal stimulus combined with a more aggressive monetary policy could have led to a quicker and more substantial recovery from the Great Recession. By using the AD/AS model as a framework, it becomes evident that addressing the negative shift in aggregate demand through coordinated policies would have been instrumental in achieving a better and faster economic rebound.
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