B C O 1 2 4 M A C R O E C O N O M I C S Task brief & rubrics Final Task brief Description: • This is an individual task. • Weight: This task is worth 45% of your overall grade for this subject. Submission: Via Moodle (Turnitin). Submissions will be accepted until Monday 3rd of May 2021 at 23:59 CEST. Formalities: • The minimum amount of words to be used is 1000 and the maximm is 1500 • You may want to include images/graphics etc. (for example from their website) to make your reasoning and argumention more visual and explicative • Font: Arial. Size: 12,5pts.

Line spacing: 1,5. Text align: Justified. • Appendices and References, do not count towards the final wordcount but are strongly recommended (referencing websites, articles, books etc.) • The in-text References and the Bibliography have to be in Harvard’s citation style. Questions: 1. (25%) The economy is in recession. The government knows that shifting the AD curve rightward by 0b would end the recession. a. If MPC = .7 and there is no crowding out, how much should Congress increase G to end the recession? b.

Explain what is the crowding out effect. Use graphs. 2. (25%) For each of the events below (A,B,C), - determine the short-run effects on output - determine how the Fed (or Central Bank) should adjust the money supply and interest rates to stabilize output A. Congress tries to balance the budget by cutting govt spending. B.

A stock market boom increases household wealth. C. War breaks out in the Middle East, causing oil prices to soar. 3. (25%) Suppose that the reserve requirement for checking deposits is 5 percent and that banks do not hold any excess reserves. 1.

If the Fed sells

B C O 1 2 4 M A C R O E C O N O M I C S

B C O 1 2 4 M A C R O E C O N O M I C S Task brief & rubrics Final Task brief Description: • This is an individual task. • Weight: This task is worth 45% of your overall grade for this subject. Submission: Via Moodle (Turnitin). Submissions will be accepted until Monday 3rd of May 2021 at 23:59 CEST. Formalities: • The minimum amount of words to be used is 1000 and the maximm is 1500 • You may want to include images/graphics etc. (for example from their website) to make your reasoning and argumention more visual and explicative • Font: Arial. Size: 12,5pts.

Line spacing: 1,5. Text align: Justified. • Appendices and References, do not count towards the final wordcount but are strongly recommended (referencing websites, articles, books etc.) • The in-text References and the Bibliography have to be in Harvard’s citation style. Questions: 1. (25%) The economy is in recession. The government knows that shifting the AD curve rightward by $200b would end the recession. a. If MPC = .7 and there is no crowding out, how much should Congress increase G to end the recession? b.

Explain what is the crowding out effect. Use graphs. 2. (25%) For each of the events below (A,B,C), - determine the short-run effects on output - determine how the Fed (or Central Bank) should adjust the money supply and interest rates to stabilize output A. Congress tries to balance the budget by cutting govt spending. B.

A stock market boom increases household wealth. C. War breaks out in the Middle East, causing oil prices to soar. 3. (25%) Suppose that the reserve requirement for checking deposits is 5 percent and that banks do not hold any excess reserves. 1.

If the Fed sells $2 million of government bonds, what is the effect on the economy’s reserves and money supply? 2. Now suppose that the Fed lowers the reserve requirement to 2.5 percent but that banks choose to hold another 5 percent of deposits as excess reserves. Why might banks do so? What is the overall change in the money multiplier and the money supply as a result of these actions?

4. (25%) Suppose that this year’s money supply is $150 billion, nominal GDP is $8 billion, and real GDP is $4 billion. a. What is the price level? What is the velocity of money? b. Suppose that velocity is constant and the economy’s output of goods and services rises by 5 percent each year. What will happen to nominal GDP and the price level next year if the Fed keeps the money supply constant? c.

What money supply should the Fed set next year if it wants to keep the price level stable? Outcomes: This task assesses the following learning outcomes: •understand the forces determining macroeconomic variables such as national output, inflation, unemployment, and interest rates; •apply macroeconomic terminology and assess macroeconomic policy suggestions; •evaluate real life situations with a practical application of the acquired tools and knowledge. Rubrics Exceptional 90-100 Good 80-89 Fair 70-79 Marginal fail 60-69 Knowledge and Identification of the main Issues 35% Identifies and demonstrates a sophisticated understanding of the main issues / problems in the case study Identifies and demonstrates an accomplished understanding of most of the issues/problems.

Identifies and demonstrates acceptable understanding of some of the issues/problems in the case study Does not identify or demonstrate an acceptable understanding of the issues/ problems in the case study Application 35% Student applies fully relevant knowledge to the situation provided Student applies mostly relevant knowledge to the situation provided Student applies some relevant knowledge to the situation provided. Some minor misunderstandings may be evident. Student applies little relevant knowledge to the situation provided. Misunderstandings are evident. Evaluation 20% Student assembles a coherent response to the question, providing a range of support and justification that leads to a well- reasoned conclusion Student assembles a good response to the question, providing support and justification that lead to a well-reasoned conclusion Student assembles a fair response to the question, providing some support and justification that lead to a well-reasoned conclusion.

Minor misunderstandings may be evident Student’s response to the question lacks coherence. Limited support and justification are provided that may or may not be well linked to the conclusion Communication 10% Student communicates ideas extremely clearly and concisely. Compliance with the guidelines on font, size, line spacing and text align will also be taken into account. Student communicates ideas clearly and concisely. Compliance with the guidelines on font, size, line spacing and text align will also be taken into account.

Student communicates ideas fairly clearly and concisely. Compliance with the guidelines on font, size, line spacing and text align will also be taken into account. Student attempts to communicate ideas clearly and concisely, with some problems. Student does not follow the guidelines on font, size, line spacing and text align.

million of government bonds, what is the effect on the economy’s reserves and money supply? 2. Now suppose that the Fed lowers the reserve requirement to 2.5 percent but that banks choose to hold another 5 percent of deposits as excess reserves. Why might banks do so? What is the overall change in the money multiplier and the money supply as a result of these actions?

4. (25%) Suppose that this year’s money supply is 0 billion, nominal GDP is billion, and real GDP is billion. a. What is the price level? What is the velocity of money? b. Suppose that velocity is constant and the economy’s output of goods and services rises by 5 percent each year. What will happen to nominal GDP and the price level next year if the Fed keeps the money supply constant? c.

What money supply should the Fed set next year if it wants to keep the price level stable? Outcomes: This task assesses the following learning outcomes: •understand the forces determining macroeconomic variables such as national output, inflation, unemployment, and interest rates; •apply macroeconomic terminology and assess macroeconomic policy suggestions; •evaluate real life situations with a practical application of the acquired tools and knowledge. Rubrics Exceptional 90-100 Good 80-89 Fair 70-79 Marginal fail 60-69 Knowledge and Identification of the main Issues 35% Identifies and demonstrates a sophisticated understanding of the main issues / problems in the case study Identifies and demonstrates an accomplished understanding of most of the issues/problems.

Identifies and demonstrates acceptable understanding of some of the issues/problems in the case study Does not identify or demonstrate an acceptable understanding of the issues/ problems in the case study Application 35% Student applies fully relevant knowledge to the situation provided Student applies mostly relevant knowledge to the situation provided Student applies some relevant knowledge to the situation provided. Some minor misunderstandings may be evident. Student applies little relevant knowledge to the situation provided. Misunderstandings are evident. Evaluation 20% Student assembles a coherent response to the question, providing a range of support and justification that leads to a well- reasoned conclusion Student assembles a good response to the question, providing support and justification that lead to a well-reasoned conclusion Student assembles a fair response to the question, providing some support and justification that lead to a well-reasoned conclusion.

Minor misunderstandings may be evident Student’s response to the question lacks coherence. Limited support and justification are provided that may or may not be well linked to the conclusion Communication 10% Student communicates ideas extremely clearly and concisely. Compliance with the guidelines on font, size, line spacing and text align will also be taken into account. Student communicates ideas clearly and concisely. Compliance with the guidelines on font, size, line spacing and text align will also be taken into account.

Student communicates ideas fairly clearly and concisely. Compliance with the guidelines on font, size, line spacing and text align will also be taken into account. Student attempts to communicate ideas clearly and concisely, with some problems. Student does not follow the guidelines on font, size, line spacing and text align.

Paper for above instructions

Introduction

Recessions are periods of economic decline characterized by reduced consumer spending, lower levels of investment, and rising unemployment. This assignment will analyze how fiscal and monetary policy tools can be employed to mitigate these downturns, focusing on concepts such as the marginal propensity to consume (MPC), the crowding-out effect, the effects of government spending, and the money multiplier.

1. Ending a Recession through Fiscal Policy

a. Calculating Government Spending Increase

To determine how much Congress should increase government spending (G) to shift the aggregate demand (AD) curve rightward by 0 billion, we can use the following formula:
\[ \text{Change in AD} = \text{Multiplier} \times \text{Change in G} \]
where the multiplier (k) is defined as:
\[ k = \frac{1}{1 - \text{MPC}} \]
Given that the MPC is 0.7, the multiplier can be computed as follows:
\[ k = \frac{1}{1 - 0.7} = \frac{1}{0.3} = 3.33 \]
Now, to find the necessary change in G to achieve an AD shift of 0 billion:
\[ 200 \, \text{billion} = 3.33 \times \text{Change in G} \]
Thus, solving for Change in G:
\[ \text{Change in G} = \frac{200 \, \text{billion}}{3.33} \approx 60 \, \text{billion} \]
Therefore, Congress should increase G by approximately billion to end the recession.

b. Explaining the Crowding Out Effect

The crowding-out effect occurs when increased government spending leads to a reduction in private sector spending. This can occur when the government borrows to finance spending, causing interest rates to rise. Higher interest rates can deter private investment as businesses find borrowing more expensive.
Graphically, the AD-AS model shows that an increase in G shifts the AD curve rightward. However, as government borrowing increases demand for funds, interest rates rise, potentially reducing investment by the private sector, shifting the AD curve leftward again. This paradox highlights the delicate balance in fiscal policy implementation (Blinder, 2000; Mankiw, 2020).

2. Short Run Effects and Central Bank Response

A. Budget Cuts by Congress

When Congress cuts government spending, the immediate effect is a leftward shift of the AD curve, leading to reduced output and possibly increased unemployment in the short run (Keynes, 1936). To stabilize output, the Federal Reserve should consider increasing the money supply through expansionary monetary policy, such as lowering interest rates.

B. Stock Market Boom Increases Household Wealth

A stock market boom increases household wealth, enhancing consumer confidence and consumption, shifting the AD curve rightward. In this scenario, the Federal Reserve might need to tighten the money supply to avoid overheating the economy and potential inflation by raising interest rates (Friedman, 1968).

C. War in the Middle East Causing Oil Prices to Soar

War can disrupt supply chains and lead to rising oil prices, increasing production costs for businesses and shifting the short-run aggregate supply curve leftward. The Fed could respond by increasing the money supply to counteract reduced output, though this may risk inflation (Blanchard & Johnson, 2013).

3. Changes in Money Supply with Reserve Requirements

1. Selling Government Bonds

If the Federal Reserve sells

B C O 1 2 4 M A C R O E C O N O M I C S

B C O 1 2 4 M A C R O E C O N O M I C S Task brief & rubrics Final Task brief Description: • This is an individual task. • Weight: This task is worth 45% of your overall grade for this subject. Submission: Via Moodle (Turnitin). Submissions will be accepted until Monday 3rd of May 2021 at 23:59 CEST. Formalities: • The minimum amount of words to be used is 1000 and the maximm is 1500 • You may want to include images/graphics etc. (for example from their website) to make your reasoning and argumention more visual and explicative • Font: Arial. Size: 12,5pts.

Line spacing: 1,5. Text align: Justified. • Appendices and References, do not count towards the final wordcount but are strongly recommended (referencing websites, articles, books etc.) • The in-text References and the Bibliography have to be in Harvard’s citation style. Questions: 1. (25%) The economy is in recession. The government knows that shifting the AD curve rightward by $200b would end the recession. a. If MPC = .7 and there is no crowding out, how much should Congress increase G to end the recession? b.

Explain what is the crowding out effect. Use graphs. 2. (25%) For each of the events below (A,B,C), - determine the short-run effects on output - determine how the Fed (or Central Bank) should adjust the money supply and interest rates to stabilize output A. Congress tries to balance the budget by cutting govt spending. B.

A stock market boom increases household wealth. C. War breaks out in the Middle East, causing oil prices to soar. 3. (25%) Suppose that the reserve requirement for checking deposits is 5 percent and that banks do not hold any excess reserves. 1.

If the Fed sells $2 million of government bonds, what is the effect on the economy’s reserves and money supply? 2. Now suppose that the Fed lowers the reserve requirement to 2.5 percent but that banks choose to hold another 5 percent of deposits as excess reserves. Why might banks do so? What is the overall change in the money multiplier and the money supply as a result of these actions?

4. (25%) Suppose that this year’s money supply is $150 billion, nominal GDP is $8 billion, and real GDP is $4 billion. a. What is the price level? What is the velocity of money? b. Suppose that velocity is constant and the economy’s output of goods and services rises by 5 percent each year. What will happen to nominal GDP and the price level next year if the Fed keeps the money supply constant? c.

What money supply should the Fed set next year if it wants to keep the price level stable? Outcomes: This task assesses the following learning outcomes: •understand the forces determining macroeconomic variables such as national output, inflation, unemployment, and interest rates; •apply macroeconomic terminology and assess macroeconomic policy suggestions; •evaluate real life situations with a practical application of the acquired tools and knowledge. Rubrics Exceptional 90-100 Good 80-89 Fair 70-79 Marginal fail 60-69 Knowledge and Identification of the main Issues 35% Identifies and demonstrates a sophisticated understanding of the main issues / problems in the case study Identifies and demonstrates an accomplished understanding of most of the issues/problems.

Identifies and demonstrates acceptable understanding of some of the issues/problems in the case study Does not identify or demonstrate an acceptable understanding of the issues/ problems in the case study Application 35% Student applies fully relevant knowledge to the situation provided Student applies mostly relevant knowledge to the situation provided Student applies some relevant knowledge to the situation provided. Some minor misunderstandings may be evident. Student applies little relevant knowledge to the situation provided. Misunderstandings are evident. Evaluation 20% Student assembles a coherent response to the question, providing a range of support and justification that leads to a well- reasoned conclusion Student assembles a good response to the question, providing support and justification that lead to a well-reasoned conclusion Student assembles a fair response to the question, providing some support and justification that lead to a well-reasoned conclusion.

Minor misunderstandings may be evident Student’s response to the question lacks coherence. Limited support and justification are provided that may or may not be well linked to the conclusion Communication 10% Student communicates ideas extremely clearly and concisely. Compliance with the guidelines on font, size, line spacing and text align will also be taken into account. Student communicates ideas clearly and concisely. Compliance with the guidelines on font, size, line spacing and text align will also be taken into account.

Student communicates ideas fairly clearly and concisely. Compliance with the guidelines on font, size, line spacing and text align will also be taken into account. Student attempts to communicate ideas clearly and concisely, with some problems. Student does not follow the guidelines on font, size, line spacing and text align.

million in government bonds, banks’ reserves will decrease by that amount because banks pay for the bonds with their reserves. This action reduces the total money supply through the money multiplier effect:
\[ \text{Change in Money Supply} = \text{Change in Reserves} \times \text{Money Multiplier} \]
With a reserve requirement of 5%, the money multiplier is:
\[ \text{Money Multiplier} = \frac{1}{0.05} = 20 \]
Thus, the decrease in money supply will be:
\[ \text{Change in Money Supply} = -2 \text{ million} \times 20 = -40 \text{ million} \]
This results in a million decrease in the overall money supply.

2. Lowering the Reserve Requirement and Excess Reserves

If the reserve requirement is lowered to 2.5%, the new money multiplier becomes:
\[ \text{Money Multiplier} = \frac{1}{0.025} = 40 \]
However, if banks choose to hold an additional 5% in excess reserves, their effective reserve requirement becomes 7.5%:
\[ \text{Adjusted Money Multiplier} = \frac{1}{0.075} = 13.33 \]
Banks may hold excess reserves for risk management or uncertainty in the economic environment. The overall change in the money supply from the lower reserve requirement might not substantially change if banks are risk-averse and unwilling to lend.

4. Money Supply, Nominal GDP, and Price Level

a. Calculating Price Level and Velocity of Money

Given:
- Money supply = 0 billion
- Nominal GDP = billion
- Real GDP = billion
To find the price level (P):
\[ P = \frac{\text{Nominal GDP}}{\text{Real GDP}} = \frac{8 \text{ billion}}{4 \text{ billion}} = 2 \]
The velocity of money (V) can be calculated using the formula:
\[ V = \frac{\text{Nominal GDP}}{\text{Money Supply}} = \frac{8 \text{ billion}}{150 \text{ billion}} \approx 0.0533 \]

b. Future Implications of Output Growth

If the economy’s output rises by 5% next year, real GDP will be .2 billion. Assuming the money supply is constant, nominal GDP will then grow to:
\[ \text{Nominal GDP} = \text{Price Level} \times \text{Real GDP} = 2 \times 4.2 = 8.4 \text{ billion} \]
Price level will then have to adjust to accommodate the change, implying potential inflation.

c. Desired Money Supply for Stable Prices

To keep the price level stable amidst a 5% increase in real output, the Fed should adjust the money supply accordingly:
\[ \text{Target Money Supply} = P \times \text{Real GDP} = 2 \times 4.2 = 8.4 \text{ billion} \]
Therefore, the Fed should set the money supply at approximately .4 billion to maintain price stability.

Conclusion

This assignment highlights the key role of fiscal and monetary policies in stabilizing the economy during recessionary periods and the complex interplay between government actions, consumer behavior, and market dynamics. Understanding these relationships is essential for effective economic policy formulation.

References

1. Blanchard, O., & Johnson, D. R. (2013). Macroeconomics. Pearson.
2. Blinder, A. S. (2000). Central Banking in Theory and Practice. MIT Press.
3. Friedman, M. (1968). The Role of Monetary Policy. American Economic Review.
4. Keynes, J. M. (1936). The General Theory of Employment, Interest, and Money. Harcourt Brace.
5. Mankiw, N. G. (2020). Principles of Macroeconomics. Cengage.
6. Mishkin, F. S. (2018). The Economics of Money, Banking, and Financial Markets. Pearson.
7. Romer, D. (2018). Advanced Macroeconomics. McGraw-Hill.
8. Samuelson, P. A., & Nordhaus, W. D. (2010). Economics. McGraw-Hill.
9. Taylor, J. B. (2009). The Taylor Rule: A Monetary Policy Tool. Federal Reserve Bank of St. Louis Review.
10. Woodford, M. (2003). Interest and Prices: Foundations of a Theory of Monetary Policy. Princeton University Press.