FOREIGN TRADE UNIVERSITY

School of Economics and International Business

US Accredited Undergraduate Program of International Business Economics

*****************************

PROBLEM SET 1

COURSE: INTERMEDIATE MACROECNOMICS – ECON 304

INSTRUCTOR: DR. NIROJ BHATTARAI

GROUP 2 MEMBERS:

1. Nguyen Thuy Duong - 1711140023

2. Nguyen Vu Ngan Hanh - 1711140028
3. Vu Hoai Linh - 1711140056
4. Nguyen Thi Minh Ngoc (leader) - 1711140066
5. Tran Quyet Thang - 1711140076

Hanoi, June 3rd, 2019

Contents
I. Part I ........................................................................................................................................... 3

II. Part 2 ......................................................................................................................................... 6

2.1. Brief explanation of the graph .............................................................................................. 6

2.2. Economic factors influencing the Fed’s decisions to target a new EFF rate and economic
effects as results of their actions .................................................................................................. 7

Works Cited ................................................................................................................................. 10

References..................................................................................................................................... 11
I. Part I

Source: Fred Economic Data

The graph demonstrated the unemployment rate from 1992 to 2019 of four groups of people over
25 categorized by their education level: less than a high school diploma, high school graduates,
some college and associate degree and bachelor's degree and higher. Overall, people who are
more highly educated are less likely to be plagued by unemployment.

It can be observed from the graph that the rate of unemployment is always lower for the more
highly educated people. Remarkably, the gap of unemployment between education levels was
markedly widened during the 2008 - 2010 recession. Before the recession, in 2007, the
unemployment rates of those with a high school degree and those with a bachelor's degree were
4.4 and 2.0 percent respectively. One year later, at the beginning of the recession, the rates rose to
5.7 and 2.6 percent before skyrocketing to the astounding rates of 9.7 and 4.6 percent in 2009. In
2010, the two unemployment rates reached their peaks of 10.3 percent and 4.7 percent. Most
notably, 2009 marked the highest jump in the rates of unemployment with the rates of high
school graduates and bachelor’s degree holders more than doubled compared to before the
recession. The unemployment disparity between the groups was also enlarged from 2.4 percent to
5.1 percent. In general, although all four groups witnessed the same trends, the fluctuation of the
unemployment rate is noticeably lessened as people move higher up the educational ladder.

Although the graph itself does not provide any free from doubt reasons as to why the noted
discrepancies between the groups existed, based on practicality and the economic circumstances
of the time, we can infer a number of explanations. In 2009, when the deteriorating economic
situation pushed the labor market in negative directions, voluntary unemployment due to
underemployment could have caused the unemployment rates to rise. Naturally, a higher level of
underemployment can lead to a higher level of voluntary unemployment if the wage does not
meet the demand of workers. During the 2009 recession when income plunged, it is likely that
the rate of unemployment increased. From 2007 to 2009, the percentage of underemployment for
high school graduates more than doubled (4.0 to 8.4 respectively). Noticeably, for the bachelor
degree and higher group, the percentage was extensively lower (2.5 in 2007 and 5.7 in 2009). It
can be clearly observed that people in a higher education group are less likely to be
underemployed at any time. Even with the heavy effects of the recession, the gap of
unemployment between the two groups were not shrunken; in fact, the disparity even nearly
doubled (1.5 and 2.7 percent respectively). It's possible that the heavy growth of underemployed
workers drove the rates of the two groups even further apart. (Andrew Sum and Ishwar
Khatiwada, 2010)

The difference in unemployment rates also partly came from the difference in bargaining power.
People with a high school diploma tend to work in blue-collar jobs (Elka Torpey and Audrey
Watson, 2014) (i.e. in factories) or work as a waiter since these jobs typically do not require a lot
of formal training, hence making them easily replaceable. High school graduates who wish to
maintain their jobs will have to accept the conditions and payment they are given. On the other
hand, a bachelor’s degree or higher will often earn people jobs in managerial level or jobs which
requires a high level of expertise. These positions cannot be easily replaced and give people
higher bargaining power. Having such a bountiful number of workers, it is hard enough for high
school graduates to compete with each other for a job; however, competition also seems to be
coming from people with a bachelor’s degree or higher as well. Throughout history, there is
always a proportion of bachelor's degree or higher owners being unemployed. (Unemployment
rate 2.1 percent for college grads, 4.3 percent for high school grads in April 2018, 2018)
Especially during the 2009 recession, a large number of people (with the more highly educated
being no exception) lost their jobs. People with higher degrees who failed to keep their jobs were
forced to switch to working manual work or lower paying jobs. For example, a physicist who
could not find another job at a lab or at a scientific institution had to become a waiter or an office
worker. The unemployed bachelor’s degree holders would try to compete with high school
graduates, increasing the competition pressure. The opposite is not true. A person who had only
completed his/her high school education simply could not work in fields that require a high level
of expertise after being laid off. It seems rather illogical for a high school graduate to become a
doctor after he/she had been laid off of his/her blue-collar job, for instance. This further increased
the gap of unemployment rate and bargaining power between the two education levels.

The above two reasons are valid throughout all periods of time. In 2009, however, there was a
time-specific reason for the significant surge of unemployment: the housing bubble burst. The
2008 recession caused the entire economy to collapse thus resulting in unemployment for a large
number of people, this also explains why the unemployment rate markedly soared in 2009. More
conspicuously, it can also be seen from the graph that during the 2008 crisis, the people with
lower education levels suffered more than those with a higher education level. This is largely due
to the fact that when the housing market collapsed, a substantial amount of home builders (most
of whom are high school graduates or lower) were laid off. The housing market collapse then led
to reduction in spending, which led to an abundance of goods in all aspects, which means that a
significant number of production workers were also laid off. Because production workers and
home building workers are similar in that they are both manual labor, the level of education
required for both occupations is similar as well. Subsequently, the disparity of the unemployment
rates between groups is further widened. During the crisis, there were a large number of people
with higher degrees losing their jobs as well: the unemployment rate of people with a bachelor’s
degree or higher increased by 2 percent, nearly doubled (from 2.6 percent to 4.6 percent). Still,
when compared with people with a college degree or less, the number was still smaller.

In conclusion, the unemployment rates for the more highly educated are always lower than those
for people with lower degrees for the three main reasons mentioned above. In my opinion,
education is a good insurance against unemployment even in difficult economic times.
II. Part 2

Source: Fred Economic Data

2.1. Brief explanation of the graph

As can be seen from the graph, over the period of nearly 45 years of the US from 1075 till now,
while the Real GDP (RGDP) and Money Stock (MS) generally saw an upward trend, the
Effective Federal Funds (EFF) rate and Unemployment rate experienced constant fluctuations in
opposite directions.

Taking a closer look into the RGDP, it witnessed quite a steady rise over the decades except for
interval recessions in the early 1980s, 1991, 2001 and 2008. The first three recessions’ scale only
ranged from 130 to 180 billion dollars decline in GDP whereas the most recent one suffered a
significant decrease in GDP of more than 500 billion dollars. However, it only took from one to
two years for the economy to recover, which subsequently makes the RGDP a progressive line
with a starting point of 5,548 billion dollars and a more than threefold ending point.

We can also observe a relationship between the RGDP and the EFF when the EFF’s substantial
reductions follow every Recession, representing the expansionary open market operation to push
aggregate demand. The significance of reductions in EFF after reaching its peaks varies across
the Recessions from approximately 2% in 1991’s and 2001’s to the highest of more than 8%
decline in the 1981’s. About the most recent Recession, the EFF was even pushed down to near 0
and only started to rise again in the late 2015. It is also noticeable that over the time the EFF has
been generally lowered.

While the MS steadily rose over this period, the rate of rise increased everytime the EFF declines.
Typically, while from 2003 up to 2007, the MS only rise gradually from 1,300 billion dollars to
near 1,400 billion, it rose to about 1,629 billion dollars in Quarter 2, 2009 in just more than a year
since the EFF rate was lowered to cure the 2008 Recession. The same situations transpire in other
recessions but at a slighter level.

Another factor fluctuating all the times is the unemployment rate, yet interestingly, in a
contradicting direction to the EFF. The low unemployment is associated with high interest rate
and vice versa as stated in the Phillips curve.

2.2. Economic factors influencing the Fed’s decisions to target a new EFF rate and economic
effects as results of their actions
Before analysing the EFF rate, it is necessary to understand what it is. “The federal funds rate is
the interest rate at which depository institutions trade federal funds (balances held at Federal
Reserve Banks) with each other overnight”. (Fred Economic Data, 2019) The EFF rate is one of
the most important interest rates in the U.S. economy since it affects monetary and financial
conditions, which in turn influences critical aspects of the broader economy including
employment, growth, and inflation. The rate also influences short-term interest rates, albeit
indirectly, for everything from home and auto loans to credit cards, as lenders often set their rates
based on the prime lending rate. The prime rate is the rate banks charge their most creditworthy
borrowers and is influenced by the federal funds rate, as well. (Chen, 2019)

It can be observed that the EFF is differently targeted in the face of Recession and Expansion.
Specifically, the EFF will be lowered during the Recession and reraised after a while of recovery.
Therefore, we will divide the analysis into Recession and Expansion to better explain the
causative factors of the targeted EFF and subsequent effects of the Fed’s actions in an effort to
achieve that.

 During Recessions: (the early 1980s,1991, 2001 and 2008)

It can be said that the Recession or the decrease in RGDP is the signal for the Fed to target a
lower EFF rate with a view to encourage economic growth. Evidence can be taken from the graph
as described about the EFF line above. By lowering the EFF, the Fed expects the subsequent
cheaper borrowing to stimulate investment and consumption, thus increase the aggregate output.

In order to achieve the targeted lower EFF rate, the Fed makes use of the open market operation,
specifically by buying bonds from its member banks to give them more reserves than they need.
Consequently, banks need to lower the EFF rate to lend out the extra funds to other banks which
in turn will reduce the price of borrowing to make more loans and profits.

Lowering the EFF rate will have two impacts, namely increasing aggregate output and demand.
Output-wise, firms are more likely to borrow money and invest in their production, which
increases the aggregate output. Similarly, households are also more willing to borrow to
consume. Moreover, chances are that households are less likely to save money in the bank with
the prospect of low interest and thus, either spend money on consumption or investment,
increasing aggregate demand. Furthermore, on seeing the increase in consumption, firms are
given further incentives to expand production. Therefore, it can be concluded that the lower EFF
rate can ultimately result in higher real GDP and recover the economy from Recessions. As in the
most recent Recession, the interest rate hovering around 0% from 2009 up till 2015 has push the
RGDP from decline to steady growth, scoring 17,031 billion dollars in 2017.

Usually the low EFF is associated with high unemployment, yet the lowered EFF can lead to
temporarily lower unemployment. Typically in the 2008 Recession, the 6 year - sustained near
0% EFF rate went along with the significant decline by half of the unemployment rate from 9.9%
in 2009. This can be explained by the fact that the low interest encourages firms to borrow and
expand productions, thus creating more job opportunities.

 Expansion: for limited time, we will only examine the expansion from 2015 hitherto
On the contrary, when the economy is performing well, the Fed might consider raising the EFF
rate to prevent overheated economy. While rising RGDP can be a good sign, an overheated one
will face with many problems. As demand goes up, so do the prices aka consequently inflation
rates. That the price keeps going up will affect the purchasing power negatively. Hence, the aim
of Fed at that time will be stable price and avoiding a shortage of labor. On seeing the RGDP
going up steadily for a decade from 1,662 billion dollars in 2009 till now, in 2015 the Fed
decided to raise the EFF rate from it sustained near 0 level gradually to 2.4% in 2019.

To achieve this higher rate, the Fed uses the contractionary open market operation, which means
it sells bonds to its member banks. As member banks base on the EFF rate to decide all of its
interest rates, the price of its lending also goes up subsequently.

High EFF rate also has influence on both the output and demand of the US. On the output side, as
borrowing becomes more expensive, firms are less likely to borrow and thus constrain their
investment and production expansion. Concurrently, households are also less willing to borrow to
purchase durable goods but more likely to save their money on the banks to earn high interest. As
can be predicted, both the aggregate demand and output will grow at a more restrained pace,
putting the economy under control. For example, after the booming of RGDP by over 1.12% due
to the decreasing EFF rate from 1991-1993, the growth rate is slowed down to just 1% from
1993-1995 when the EFF rate was reraised.

In conclusion, the Fed will target different EFF rate in response to prevailing economic
situations, say Recession or Expansion, to either recover the economy from declining RGDP or
stabilizing price. Usually, the targeted rates will satisfy the intended outcome of Fed in terms of
GDP, unemployment rate, inflation, etc. However, monetary policies alone cannot work
effectively and are not without defects. A typical example is the liquidity trap in the 2008
Recession. The significant economist Paul Krugman noted that tripling of the monetary base in
the US between 2008 and 2011 failed to produce any significant effect on domestic price indices
or dollar-denominated commodity prices and further slashing the interest rate was impossible
because it was near 0 already. (Wikipedia, 2019) Hence it is advisable that Fed’s actions must be
combined with fiscal policies to ensure economic health.
Works Cited
1. Fred Economic Data. (n.d.). Retrieved from https://fred.stlouisfed.org/graph/?g=o3sy
2. Andrew Sum and Ishwar Khatiwada. (2010). The Nation’s underemployed in the Great
Recession of 2007-09. Monthly Labor Review, 9. From
https://www.bls.gov/opub/mlr/2010/11/art1full.pdf
3. bls.gov. (n.d.). From https://www.bls.gov/careeroutlook/2014/article/education-level-and-
jobs.htm
4. Fred Economic Data. (n.d.). Retrieved from https://fred.stlouisfed.org/graph/?g=o2Uf
5. Chen, J. (2019, 4 18). Investopedia. From
https://www.investopedia.com/terms/f/federalfundsrate.asp
6. Elka Torpey and Audrey Watson. (2014, 9). Education level and jobs: Opportunities by state.
Career Outlook.
7. Fred Economic Data. (2019, 5 1). From https://fred.stlouisfed.org/series/FEDFUNDS
Unemployment rate 2.1 percent for college grads, 4.3 percent for high school grads in April 2018.
(2018, 5 10). TED: The Economics Daily image.
8. Wikipedia. (2019, 5 16). From
https://en.wikipedia.org/wiki/Liquidity_trap#Global_financial_crisis_of_2008
References
1. BLS. (n.d.). More education, less unemployment. OOChart.
2. Maine Dept. of Labor. (n.d.). The Relationship Between Education and Unemployment and
Earnings. Education Unemployment Earnings.
3. NCES. (2019). Employment and Unemployment Rates by Educational Attainment.
4. OECD. (2012). How does education affect employment rates? Education at a Glance 2012.