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New Economic School

Macro I (Module I, 2014-2015)
Homework Assignment #1
Due: Friday September 13, 2014 (before 5 p.m.)
All assignments should be written in English.
You should return your own HAs. You can return your HA either in electronic or paper format. If
you chose the latter, please answer each problem in a separate notebook. The total number of points
is 100.
Problem 1 (True / False / Uncertain) (15 points)
Based on the information obtained from class, please, label each of the following statements true,
false, or uncertain. Explain briey.
Some of these statements may require you to collect data (although we also discussed them in
lecture). As mentioned in lectures, one very easy source for data is the Federal Reserve Bank of
St. Louis FRED database.The series that measures annual real GDP is GDPCA (not seasonally
adjusted). The series that measures annual nominal GDP is GDPA.
1
1 U.S. GDP was roughly about 29 times larger in 2012 than it was in 1960. This is evidence of
strong economic performance, on average during the period.
2 The data between 1960 and 2010 suggest that an expansion is associated with a reduction
of the unemployment rate and that an average GDP growth rate of roughly 3% reduces the
unemployment rate to 0.
3 If the Russian CPI is currently at 112 and the U.S. CPI is at 96, then there is ination in
Russia but deation in the United States.
4 Assume that in a given period and in a country that is a net exporter of oil (e.g., Russia) the
CPI and the GDP deator are the same. If the price of oil suddenly increases relatively to
that of other goods (everything else equal), it is likely that the CPI index will exceed the GDP
deator.
5 An increase in the unemployment will most likely increase the participation rate.
Problem 2 (GDP and Recessions) (30 points)
1 Measured vs. true GDP
You became recently much better organized and nd yourself able to work every morning for
an extra hour. This increases your annual earnings an additional $2,000. Nevertheless you need
to purchase an extra coee and eat an extra croissant at an annual cost of $800.
1
http://research.stlouisfed.org/fred2/
1
1.1. By how much does measured GDP increase in that year?
1.2. Do you think the increase in measured GDP accurately reects the eect on output of
your decision to work? Explain.
2 Dening recessions
In lecture, we explained how the BEA denes a recession.
2
For this question, please download
quarterly data on GDP growth from the Bureau of Economic Analysis (Seasonally Adjusted).
3
2.1. Based on this denition, use your BEA data to identify recessions occurred since 1960 in
the U.S. How many do you nd? Which one was the most severe?
2.2. Now look at the number of recessions identied by the National Bureau of Economic
Research (also known as NBER) at http://www.bea.gov/faq/index.cfm?faq_id=485.
Is the NBERs answer dierent? If yes, is there something wrong with your calculation?
Problem 3 (Equilibrium) (20 points)
Assume an economy described by the following behavioral equations:
C = 160 + 0.6Y D
I = 150
G = 150
T = 100
1 Solve for equilibrium output (Y ), disposable income (Y
D
) and consumption spending (C).
2 What is total demand. Is it equal to production? Explain.
In the following, assume that G is now equal to 110.
3 Solve for equilibrium output. Compute total demand. Is it equal to production? Explain.
4 Compute private plus public saving. Is the sum of private and public saving equal to investment?
Explain.
Problem 4 (Fiscal stabilizers) (20 points)
In our decomposition of GDP, we have assumed that the scal policy variables G and T are
independent of the level of income. In the real world, however, this is not the case. Taxes typically
depend on the level of income and so tend to be higher when income is higher. Lets examine how
this automatic response of taxes can help reduce the impact of changes in autonomous spending on
output.
2
See BEA denition of a recession at http://www.bea.gov/faq/index.cfm?faq_id=485
3
Table 1.1.1, http://www.bea.gov/iTable/
2
Consider the following behavioral equations:
C = c
0
+c
1
Y
D
T = t
0
+t
1
Y
Y
D
= Y T
Assume that G and I are both constant and that t
1
is between 0 and 1.
1 Solve for the equilibrium level of output.
2 What is the multiplier? Does the economy respond more to changes in autonomous spending
when t
1
is 0 or when t
1
is positive? Explain.
3 Why is scal policy in this case called an automatic (or scal) stabilizer?
4 Solve for the equilibrium level of taxes.
It is often argued that a balanced budget amendment would actually be destabilizing. Suppose that the
government starts with a balanced budget and that there is a drop in c
0
.
5 What happens to Y? What happens to taxes?
6 Suppose that the government cuts spending in order to keep the budget balanced. What will
be the eect on Y? Does the cut in spending required to balance the budget counteract or
reinforce the eect of the drop in c
0
on output? (No need to do the algebra. Use your intuition
and give the answer in words.)
Problem 5 (Exit strategy) (15 points)
In ghting the recession associated with the nancial crisis, taxes were cut and government spending
was increased. The result was a very large government decit. To reduce that decit, taxes must be
increased or government spending must be cut. This is called the exit strategy from the large decit.
1 How will reducing the decit in either way aect the equilibrium level of output in the short
run?
2 Which will change equilibrium output more: (i) cutting G by $100 billion (ii) raising T by $100
billion?
3 How does your answer to part (b) depend on the value of the marginal propensity to consume?
4 You hear the argument that a reduction in the decit will increase consumer and business
condence and thus reduce the decline in output that would otherwise occur with decit
reduction. Is this argument valid?
3