Bco124 Macroeconomics ✓ Solved

BCO124 MACROECONOMICS 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

Bco124 Macroeconomics

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.

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.

Paper for above instructions

Introduction

Macroeconomics is pivotal in understanding how monetary and fiscal policies can influence economic conditions, particularly in achieving stability during recessionary periods. This paper explores the intricacies of government fiscal measures and monetary policy responses as related to economic phenomena such as reduced spending, wealth fluctuation from stock market changes, and the fallout from geopolitical crises.

Question 1

A. Government Spending Increase to End Recession

The goal is to shift the Aggregate Demand (AD) curve rightward by 0 billion. To find out how much Congress should increase government expenditure (G), we utilize the Keynesian multiplier effect, which is calculated using the formula:
\[
Multiplier = \frac{1}{1-MPC}
\]
Given that the Marginal Propensity to Consume (MPC) is 0.7:
\[
Multiplier = \frac{1}{1-0.7} = \frac{1}{0.3} = 3.33
\]
Now, to produce a shift in AD of 0 billion, we rearrange the equation to solve for the change in government spending (∆G):
\[
\Delta AD = Multiplier \times \Delta G
\]
Substituting the known values:
\[
200 = 3.33 \times \Delta G
\]
Solving for $\Delta G$:
\[
\Delta G = \frac{200}{3.33} \approx 60 \text{ billion}
\]
Thus, Congress should increase government spending by approximately billion to end the recession.

B. Crowding Out Effect

The crowding-out effect occurs when increased government spending leads to higher interest rates, which in turn reduce private sector spending. This is illustrated by a leftward shift in the investment curve as rising interest rates make borrowing more expensive for households and businesses, thus impeding economic growth.
Graphical Explanation:
- Y-Axis: Interest Rates
- X-Axis: Quantity of Loanable Funds
- The initial demand curve shifts to the right due to increased government borrowing, pushing interest rates up and shifting the investment demand curve leftward.
This can be visualized as a shift in the equilibrium from E1 to E2 in the loanable funds market, indicating a decrease in private investment due to increased government borrowing (Mankiw, 2021).

Question 2

Event A: Government Spending Cuts

If Congress tries to balance the budget by cutting government spending, the immediate short-run effect will be reduced output due to diminished aggregate demand. Given the Keynesian perspective, an equal reduction in G translates directly into a decrease in AD, leading to higher unemployment and slower growth.
To stabilize the output, the Federal Reserve (Fed) should lower interest rates by increasing the money supply through open market operations. This will encourage borrowing and investment.

Event B: Stock Market Boom Increases Household Wealth

An increase in household wealth from a stock market boom would lead to an increase in consumer spending. The short-run effect would likely be an increase in output as consumption rises.
To counteract inflationary pressures, the Fed might need to decrease the money supply, possibly through selling government securities to increase interest rates and temper spending.

Event C: Middle East War Causes Oil Price Surge

The war leading to increased oil prices would decrease aggregate supply, causing a leftward shift in the AS curve. This would potentially lead to stagflation—a situation of rising prices combined with falling output.
To stabilize the economy, the Fed might need to conduct expansionary monetary policy, which may include lowering interest rates or increasing the money supply to support growth, despite the risk of higher inflation.

Question 3

A. Sale of Government Bonds

If the Fed sells

Bco124 Macroeconomics

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.

million in government bonds and the reserve requirement is 5%, the effect can be calculated with the money multiplier formula:
\[
Money Multiplier = \frac{1}{Reserve Requirement} = \frac{1}{0.05} = 20
\]
With the sale of bonds, reserves in the banking system decrease by

Bco124 Macroeconomics

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.

million, leading to a potential decrease in money supply by:
\[
Change in Money Supply = -2 \text{ million} \times 20 = -40 \text{ million}
\]
This illustrates how a contractionary monetary policy can significantly decrease the money supply available for lending.

B. Lowering Reserve Requirement with Excess Reserves

If the Fed lowers the reserve requirement to 2.5% but banks decide to hold 5% of deposits as excess reserves, the effective reserve requirement becomes 7.5%.
- The new money multiplier would be:
\[
Money Multiplier = \frac{1}{0.075} \approx 13.33
\]
Banks might opt to hold excess reserves during uncertain economic periods to mitigate risk. The overall change in the money supply would depend on the bank’s capacity to expand lending, reducing the anticipated increase in the money supply as a result of the multiplier’s effect.

Question 4

A. Price Level and Velocity of Money

With a money supply of 0 billion and nominal GDP of billion, the price level can be calculated as follows:
\[
Price Level = \frac{Nominal GDP}{Money Supply} = \frac{8 \text{ billion}}{150 \text{ billion}} \approx 0.0533 \text{ or } 53.33 \text{ (index)}
\]
Velocity of money (V) can be calculated using the equation of exchange: MV = PQ, thus:
\[
V = \frac{PQ}{M} = \frac{8 \text{ billion}}{150 \text{ billion}} \approx 0.0533
\]

B. Future Nominal GDP and Price Level

Assuming a 5% increase in output, next year's nominal GDP will be:
\[
New \text{ Nominal GDP} = Current \text{ Nominal GDP} \times (1 + 0.05) = 8 \text{ billion} \times 1.05 = 8.4 \text{ billion}
\]
If the Fed keeps the money supply constant, this indicates an increase in output without a corresponding rise in prices, implying a fall in the price level.

C. Adjusting Money Supply

To maintain price level stability in light of a constant money supply but increasing output, the Fed needs to increase the money supply proportionally to output growth.
\[
New Money Supply = Current Money Supply \times (1 + 0.05) = 150 \text{ billion} \times 1.05 = 157.5 \text{ billion}
\]

Conclusion

The complexity of macroeconomic policies highlights the delicate balance between government spending, investment, monetary supply, and price levels. A nuanced understanding and responsive policy implementation are essential to foster economic stability and growth during times of recession and crisis. As such, fiscal measures, alongside prudent monetary policy, function as critical tools in managing economic health.

References

- Mankiw, N.G. (2021). Macroeconomics. Worth Publishers.
- Blanchard, O. (2017). Macroeconomics. Pearson.
- Krugman, P., & Wells, R. (2018). Macroeconomics. Worth Publishers.
- Taylor, J.B. (1993). "Discretion versus policy rules in practice". Carnegie-Rochester Conference Series on Public Policy.
- Friedman, M., & Schwartz, A.J. (1963). A Monetary History of the United States, 1867-1960. Princeton University Press.
- Romer, D. (2019). Advanced Macroeconomics. McGraw Hill.
- Bernanke, B.S. (2020). "Monetary Policy Since the Onset of the Crisis". National Bureau of Economic Research.
- Federal Reserve Bank of St. Louis (2022). "Monetary Policy: An Overview”.
- Stock and Watson. (2016). Introduction to Econometrics. Pearson.
- Woodford, M. (2003). Interest and Prices: Foundations of a Theory of Monetary Policy. Princeton University Press.

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