Final Exam – Econ 304 – Chuderewicz – Fall 2017



Final Exam – Econ 304 – Chuderewicz – Fall 2018

Name ______________________________ Last 4 (PSU ID) __________

Section: Please Check:

112 Chambers Building (9:05 - 9:55 am section 001) ______________

022 BBH Building (11:15 - 12:05 pm section 002) ______________

PLEASE PUT THE FIRST TWO LETTERS OF YOUR LAST NAME ON TOP RIGHT HAND CORNER OF THIS COVER SHEET

315 points total - 110 minutes total time

First Question 160 points (spend 55 minutes)

Second Question 80 points (spend 28 minutes)

Third Question 75 points (spend 27 minutes)

YES, THIS IS THE FINAL EXAM!!!!! NO CALCULATORS PERMITTED

NOTE: IF YOU DO THE INCORRECT QUESTION BY ACCIDENT OR ON PURPOSE, YOU WILL RECEIVE ZERO ON THAT QUESTION: NO EXCEPTIONS

IF AN ACE IS DRAWN - DO THE STAGFLATION OF THE 1970s

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IF A TWO IS DRAWN - DO THE NEW ECONOMY OF THE 1990s

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IF A THREE IS DRAWN - DO THE GREAT RECESSION OF THE 2000s

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a) (80 points total: 40 points for correct and completely labeled graphs, 40 points for explaining the movements from point A to point B and so on: Stagflation has points A,B,C,D, New economy has points A and B, Great Recession has Points A,B,C)

In the space below, depict the episode that was chosen by the card flip (Stagflation, New Economy, or Great Recession) on the 4 graphs as we did in class - the MP curve on top left, the IS curve on top right, the AS - AD curve on bottom right, and the Phillps curve on bottom left. Label the relevant points from the appropriate diagram on the previous page. Make sure you completely label all graphs including all the relevant shift variables.

write your explanation from point to point referring to all your graphs in the space below: Please explain in as much detail as possible.

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More room here:

b)(20 points total: 10 for graph and 10 for explanation) Using the episode chosen with the card flip, depict the points above on the two period consumption model. In your explanation, explain exactly why consumption changes the way it does from each point to each point. Be sure to refer to why the budget constraint changes the way it does!

c)(20 points total: 10 for graph and 10 for explanation) Now depict the chosen episode and the associated points using the UC/MPK diagram. Be sure to explain exactly why the profit maximizing K* changes the way it does (or doesn't) as we move from Point to Point. What are the implications on investment? Explain.

d)(20 points total: 10 for graph and 10 for explanation) Now depict the chosen episode and the associated points using the closed economy S = I diagram. Be sure to explain exactly why the curves change the way they do including all the relevant shift variables. Again, be sure to explain the intuition and we move from point to point and how and why we get back to the closed economy equilibrium (explain how the goods market clears!).

Part e), the last part of this question depends on the card flip:

If Ace, Stagflation, do e) Part Ace (Stagflation), if Two, do e) Part Two (New Economy), if Three, do e) Part Three (Great Recession)

e) Part Ace (Stagflation) (20 points) Using a production function and labor market diagram (please draw vertically with production function up top), explain why we move from point A to point B in the stagflation episode. Explain in detail what happens in the labor market and how the labor market clears exactly. With regard to the production function, name two reasons why output changed the way it did.

e) Part Two (New Economy) (20 points) Using a production function and labor market diagram (please draw vertically with production function up top), explain why we move from point A to point B in the New Economy Episode. Explain in detail what happens in the labor market and how the labor market clears exactly. With regard to the production function, name two reasons why output changed the way it did.

e) Part Three (Great Recession) (20 points) We discussed the perplexing reality of a flat SR Phillips curve during this period. We noted that after the Bernanke Fed took the 'date' off of their forward guidance they replaced it with "at least as long as the unemployment rate remains above 6 1/2 percent." This forward guidance didn't work so well ... why? .

Referring to the article How Long Can the Great Jobs Picture Continue? The Fed Thinks Indefinitely and the graphic below, explain why the Phillips curve is currently flat. In order to support your answer, explain the theory as to why the Phillips curve is supposed to have a negative slope.

Finally, explain how the articles titled Pause Interest-Rate Hikes to Help the Labor Force Grow and How Retiring Baby Boomers Hinder U.S. Wage Growth, support the idea that the current short-run Phillips curve is indeed flat!

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USE THE SPACE BELOW AND ON THE NEXT PAGE FOR YOUR ANSWER

SECOND QUESTION – DO ONLY ONE OF THE FOLLOWING TWO QUESTIONS, FOUR OR FIVE, DEPENDING ON THE CARD FLIP.

FOUR: Do this question if a four is flipped (80 points- 40 for graphs and 40 for explanation) We discussed the period often referred to as the 'heyday' of the Keynesians during the 1960's. From the article: (12/31/1965) "We are all Keynesians Now" we discussed the following excerpt:

Labor Secretary Willard Wirtz argues that the Government should continue pushing and stimulating the economy, even at the risk of some inflation, in order to bring unemployment down to 3%.

The relevant Phillip's curve graphic is below:

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Please use the template below to depicts points A, B, and C on the four diagrams. Please use the space below to begin your explanation and continue your answer in the space below the template. Write your explanation from point to point referring to all your graphs in the space below: Please explain in as much detail as possible.

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FIVE: Do this question if a five is flipped (80 points- 40 for graphs and 40 for explanation) We discussed the Volcker dis-inflation during the 1980's.

The relevant Phillip's curve graphic is below:

[pic]

Please use the template below to depicts points A, B, and C on the four diagrams. Please use the space below to begin your explanation and continue your answer in the space below the template. Write your explanation from point to point referring to all your graphs in the space below: Please explain in as much detail as possible.

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THIRD QUESTION - DO ONE OF THE FOLLOWING TWO QUESTIONS DEPENDING ON THE COIN FLIP

DO THIS QUESTION IF A SIX IS FLIPPED

SIX (75 POINTS - 15 points for each economic construct)

We discussed Jerome Powell's recent statement about what it is like to conduct monetary policy these days.

From the WSJ: Fed Shifts to a Less Predictable Approach to Policy Making

Officials on uncertain path, likely tying decisions to short-term economic data (11/27/18)

Fed Chairman Jerome Powell recently compared the task to walking through a room full of furniture when the lights go out. “What do you do? You slow down. You stop, probably, and feel your way,” he said at an event earlier this month. “It’s not different with policy.”

In class we discussed this analogy in more detail. When he states "You stop, probably and feel your way" - what exactly is he feeling for? We discussed 5 different pieces of furniture that he is 'feeling' for. Of course these are 5 different economic constructs that are SO important in determining the future path of monetary policy -

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In the space below, identify and explain each of these 5 economic constructs, one by one. For each construct be sure to explain how we attempt to measure the construct, what the current estimate of each construct is and where the actual (current) numbers are relative to the current estimate. Then explain why these are so important in terms of guiding the Fed to our dual mandate (please use diagrams to support your answers). Finally, comment on what President Trump would want these constructs to be (high or low) and why!! In other words, if these constructs are where President Trump wants them, maybe he will quit bashing Jerome Powell!

From the USA Today, 11/28/18

President Donald Trump took fresh aim at Jerome Powell on Tuesday, slamming the Federal Reserve chairman he hand-picked for the job in an interview with The Washington Post.

The president, who has frequently expressed his displeasure with the central bank chief's repeated interest rate hikes this year, said he's "not even a little bit happy" with his appointment of Powell earlier this year.

Trump told the newspaper that he thinks the Fed – which has hiked its key short-term rate three times this year to a range of 2 percent to 2.25 percent – is "way off base" and is "making a mistake." 

DO THIS QUESTION IF A SEVEN IS FLIPPED (75 POINTS)

SEVEN

We discussed the evolution of how the Fed targets the federal funds rate. As we know, the mechanics of influencing the federal funds rate has changed dramatically since the Great Recession. Currently, as of 11/29/2018, the federal funds rate is at 2.20% with the range being 2 - 2.25%. The current probability of the Fed raising the target range for the federal funds rate up to 2.25 - 2.50% at their Dec. 2018 FOMC meeting is about 80%. The current iRRP = 2% and the current iOR = 2.20%

a)(30 points). Assuming that the Fed did indeed do the expected at their upcoming FOMC meeting, how exactly would they get the federal funds rate into its new range. Discuss how the implementation note would change along with describing exactly what is happening in the federal funds market before and after the change in policy.

Now draw a graphic of these overnight markets with time on the horizontal axis. If the Fed does as expected, the change will officially be made Dec. 19, 2018 (this is the second of the 2 day FOMC meeting). Be sure to explain your graph and what happens after the change in policy exactly.

b)(35 points total)) Before the Great Recession things were much different with regard to monetary policy and the setting of the federal funds rate.

i)(10 points) Explain how the federal funds market worked before the Great Recession - what was happening at the trading desk at the FRBNY exactly (the phones) and how was the federal funds rate determined in this market?

ii)(10 points) Let play pretend so that we are back to the old system and the federal funds target is 2.20% which of course is equal to the current federal funds rate. How would the Fed, using the old system, target the Fed funds rate on a daily basis? Draw a graph of the reserve market to support your answer and label this initial point as point A.

iii)(10 points) Staying with our 'pretend' old system, how would the Fed raise the target for the federal funds rate by 25 basis points? Be specific with your explanation and label as point B on your diagram.

iv)(5 points) What would determine how successful the Fed would be in terms of hitting their new target?

c) (10 points) Consider the Graphic below: [pic]

Notice that back in May, 2016, the federal funds rate was pretty much right in the middle of the target range and I am sure the Fed was pleased. More recently (Nov 1, 2018), the federal funds rate is near the top of the range. Explain why the federal funds rate is near the top of its range (actual equal to the iOR) and if the Fed wanted to get it back to the middle of its range, what could it do exactly? Apply your answer to what they would do at their next FOMC meeting!

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