Quiz 11 - Questions 4 and 5

When doing Questions 4-5. Please use the following table. The table in the quiz did not transfer through clearly.

Balance of Payments - what you need to know

For the purposes of the final, here is what you need to know about Chapter 34

1) Balance of Payments - A record of all transactions between households, firms and the government of one country and the rest of the world
a) current account - trade balance + net transfers + net interest income
i) trade balance = exports - imports. Exports +, imports -
ii) net tranfers - gifts between countries. Gift to US +, gift to other countries -
iii) net interest income - income you receive from coupon payments (bonds) and dividends (stocks). US recieves (+), US gives (-)

b) Capital account - measures real asset flows (purchases of stocks, bonds, real estate, etc)
Foreign purchase of a US asset (+)
US purchase of a foreign asset (-)

c) reserve account - account that automatically balances out the BOP, measures official reserves
Foreign government purchase of USD (+)
US Fed purchase of foreign (-)

Basically, anything that would increase the demand for US dollars is a plus for the BOP, anything that would require selling of US dollars would be a negative.

II) USD appreciation/depreciation
a) Fed policy - If the Fed raises interest rates, the return on bonds goes up and this makes holding US dollars more attractive, all else equal. The reverse also holds true
b) Demand for US assets (appreciation)
c) demand for US goods (appreciation)
d) demand for foreign assets (depreciation)
e) demand for foreign goods (depreciation)

Quiz 11 - For study purposes

I will paste the answers below

EC 207 – Intro to Macro Economics
Quiz 11 – In class Quiz on Chapters 33 and 34
12/13/2007
Professor Festa

1) _______When nations specialize according to their comparative advantage
a) total production and consumption in the world increases
b) consumption rises in one country but falls in all others
c) Total world production rises but total consumption in the world declines.
d) Poor people suffer

2)_______If there are two goods and two countries, then one country can have
a) a comparative advantage in only one good
b) a comparative advantage in both goods
c) a higher opportunity cost of producing both goods
d) a lower opportunity cost of producing both goods.

3) ______ The ability to produce a good or service at a lower opportunity cost than other producers is
a) absolute advantage
b) the quota system
c) intellectual property
d) comparative advantage.



Product
United States
Mexico
Computers
8
3
Bicycles
2
6




Refer to the above table for 4-5

4) Referring to the above table, what is the cost of producing (opportunity cost) one bicycle in the United States________? What is the opportunity cost of producing one bicycle for Mexico
a. 4 computers, 0.5 computers
b. 0.25 computers, 2 computers
c. 2.67 bicycles, 0.33 computers
d. 0.375 computers, 3 bicycles.


5) ______Referring to question 4, which of the following would be a correct statement
a) The United States has a comparative advantage in bicycles
b) The United States has a comparative advantage in computers
c) Mexico has a comparative advantage in computers
d) Mexico has a comparative advantage in both goods.

6)_______The balance of trade is
a)The difference between exports and imports
b)The value of all goods and services produced
c) A measure of real asset flows
d) The amount of currency central banks hold


7) _________When the value of exports exceeds the value of imports then
a) changes in productivity will occur
b) international trade is in balance
c) the country is running a deficit
d) the country is running a surplus

8) ________ A record of all transactions between households, firms and the government of one country and the rest of the world is the
a) a balance of trade
b) balance of payments
c) international monetary fund
d) government budget

9) _______Which of the following would be considered a positive contribution to the capital account from the US perspective
a) US purchase of a Nokia Cell Phone
b) US purchases of Nokia stock
c) A Swedish purchases of US Dell stock
d) A Swedish purchase of a US Dell computer

10) _______Which of the following would cause an appreciation in the US dollar, all else equal?
a) The federal reserve unexpectedly raises interest rates
b) The federal reserve unexpectedly lowers interest rates
c) US demand for Swiss Clocks surges, causing imports to rise
d) Foreign demand for Dell computers falls, causing exports to fall.


Answers:
A
A
D
A
B
A
D
B
C
A

Class cancelled tonight, but final still set for Tues

I just got a call from the college. Class has been cancelled tonight so we will not be having our final quiz. So I will have to make some amendments.

1) THE FINAL EXAM IS STILL SCHEDULED FOR DEC 18th.
2) QUIZ 11 has been permanently cancelled. Instead I will post the quiz online with the answers and you can use it as a reference for studying
3) I will be posting a review for the revelant chapters between today and Sat. The most important being Chapter 34 on the balance of payments.
4) Due to losing our final review class, I will allow you to turn in one final extra credit project. Here are the terms. It is the same as what currently exists (find an article, write a double spaced one page summary relating it to the class). However, instead of applying it to your quiz average I will apply it to the final. Instead of being worth 2 points I will make it worth 4 points on your final.

If you have any questions, please e-mail me.

Quiz 10 - Due Dec 11

Intro to Macroeconomics - Quiz 10
Professor Matthew Festa
Due in class Tues, Dec 11
Balance of Payments and the exchange rate

1) (5 points) - Tell me whether the following will go in the current, capital or reserve account and whether it is a positive or a negative in its account.
a) A European purchase of a US Dell laptop
b) A US purchase of a Swiss watch
c) A Japanese purchase of Cisco Systems, a US company
d) A US citizen purchase of a Nokia Cell phone, a Swedish company
e) US receipt of interest income from a German bond

2) (5 points) Tell me whether the following would cause an appreciation or depreciation in the US dollar (USD)
a) The new Dell one machine, a US based company, catches fire around the world and is heavily demanded by foreigners.
b) Income among US citizens rises and the demand for foreign produced Cashmere sweaters increases
c) The US housing market is strong and there is good profit to be made by investing in US real estate, even if you don't live in the US
d) Smoogle, the next best Internet search engine, catches on and issues stock. The company is based out of Britain.
e) The federal reserve cuts the Fed funds rate and this causes a general decline in overall rates among US bonds.

Macro Quiz 9 - Due in class Tues Dec 4th

Please use this link for Quiz 9.

Free trade and US sock industry

Greg Mankiw has an interesting post on how the US sock industry has been affected by free trade. Of course, the flip side of this is that socks are being produced more efficiently at a lower cost while jobs/capital has shifted towards areas where we have a comparative advantage,

Class i on Tues

I called the college and classes are our class is scheduled for tomorrow. I will return the tests on that date.

More data - initial claims

Remember in class I told you that the data is coming in all over the place? Well initial claims were just released and came in fairly positive. You can read about it here .

The number of U.S. residents filing for unemployment benefits decreased by 13,000 last week to stand at 317,000, the lowest level in a month, the Labor Department reported Thursday.'

but

The four-week average of new claims rose by 2,000 to 329,750, the highest level since the week of April 21. The four-week average is considered a better gauge of labor market health than the volatile weekly number because it smoothes out one-time events such as weather, strikes or holidays

on the other hand

Economists are puzzled that unemployment claims have remained fairly steady and low even as the nation's job growth has slowed significantly in the past few months.
One explanation could be that firms are not hiring because they're uncertain about the future. That same uncertainty keeps them from laying off workers who might be needed if the economy rebounds

But the job market hasn't slowed to a worrisome extent yet. You can read about the Oct payroll report here. On the other hand, data on the housing is extremely weak and point to continued declines. With the inventories of homes remaining high, there is a very strong case to be made that home prices have a ways to fall and this could hurt consumption, and job growth, in the future.

As you can see, the Fed's job is not as simple as black or white. There is a lot of grey.

Topic 9 (Overview and summation of Chap 10-17)

I) Neoclassical Aggegate supply and demand curve
a) Best represenation is on Page 320 in your book
b) The goal of this graph is to combine the insights of the classical and keynesian viewpoints. So we have a
1) long run aggregate supply curve
2) short run aggregate supply curve
3) aggregate demand curve

II) What should the fiscal and monetary authorities do?
a) Fiscal
1) recessionary gap (make sure you know graph)
i) cut taxes
ii) increase government spending
2) inflationary gap (make sure you know graph)
i) raise taxes
ii) decrease government spending.
3) at equilibrium - have the budget balanced
4) automatic stabilizers - unemployment benefits, progressive tax code

b) monetary policy
1) The Fed has a dual mandate: maintain price stability and full employment. Accomplishing these goals require conflicting policy actions. Here is a rough guide as to what the fed should do.

2) recessionary gap (ditto)
i) open market purchase of government bonds (cut in fed funds rate)
ii) cut discount rate
iii) cut in reserve requirement ratio

3) inflationary gap (ditto)
i) open market sale of government bonds (raise in fed funds rate)
ii) raise discount rate
iii) rase the reserve requirement ratio

III) Critiques of fiscal and monetary policy
1) Fiscal policy
a) Time lag
b) government failure (rational ignorance, biased voters)
c) ricardian equivalence (i.e. rational expectations)

2) Monetary policy
a) Monetary policy may be unable to affect interest rates (liquidity trap)
b) Long term rates may not respond to policy changes.

IV) Examples of policy action
1) 2001 recession, 2003 Fed policy to counteract possible deflation.
2) 2004-2006 rate hikes by Federal reserve in order to prevent inflation
3) 1980 disinflationary action by Volker

Quiz 7 - Due Tues Nov 6

Quiz 7 - Monetary Economics (15-17)
Professor Matthew Festa
EC207 - Intro to Macroeconomics
Due in Class Nov 6, 2007

1) (2 points) - Identify whether each of the following items is counted in M1 only, M2 only, both M1 and M2, or neither

a) A $1000 balance in a transaction deposit at a bank
b) $50,000 certificate of deposit (CD) at your bank
c) $200,000 certificate of deposit (CD) at your bank
d) $50 traveler's check
e) $500 worth of stock in Google.

2) a)(1 point) The required reserve ratio is 20%. What is the potential money multiplier?
b) (1 point) If the Fed injects $10 million dollars into the banking system, what is the maximum the economy can expand?

3) (2 points) Draw the liquidity preference graph (money demand and money supply). Name the 3 tools of the Federal reserve? Which is the one they use the most?

4) (2 points) The Fed says they plan on cutting 25bps of the tool they use the most. Show the effect on the graph. Tell me whether the equilibrium interest rate and quantity of money will be higher or lower?

5) (2 points) Explain the equation MV=PY. Assuming that Y and V are fixed, what will happen if the Fed continually increases M? Is this a classical or Keynesian argument? Show the effect on an AS/AD graph.

Jobs Report

The single biggest monthly report on the economy is the Non Farm Payrolls report, a measure of how many jobs have been created in the economy during a given month. This report is released the first Friday of every month and is usually market moving (that is, stocks and bonds react to it). You can read the WSJ report on today's figure here

The WSJ reports that NFP rose a healthy 166 thousand gain in employment for Oct, helping to ease concerns that a recession is immanent. More important than the headline figure, which can be distorted because it is always revised, is the 3m average of 117k. 117k average over 3m is a healthy figure given market conditions.

Why is this important? Think of jobs as a way to estimate whether aggregate demand is going to be strong or weak. If employers were expecting AD to be weak, then they probably would not be hiring employees in order to boost output. Further, an increase the amount of jobs boosts income and this should help to support spending. This is extra important at a time when falling home prices threaten to hurt consumer spending.

However, economists debate whether this report can be used to predict the economies future. Some economic data is considered to be a "leading indicator of the economy" while others tend to be a "lagging indicator." Click here for a detailed breakdown over which economic data is considered leading or lagging.

In general, the unemployment rate is considered to be a lagging indicator (that is, the economy will slow and then the unemployment rate will rise). The payroll report is sometimes considered a lagging indicator but other times is considered a "coincident" indicator (it falls as the economy is weakening). In this case the markets are likely to consider it a coincident indicator and this should help ease concerns over a recession.

However, all is not well since the stock market fell yesterday and data on the housing market has been extremely weak. Although the stock market could see a rally today, I doubt it will return to the highs of early Oct before the latest round of worries commenced. It is, however, safe to say the Fed will not be cutting next month with GDP and employment coming in rather strong (pointing to decent AD) and oil prices so high (pointing to possible near term inflation).

Topic 8 (Chapter 17)

I) Demand for Money
a) Money balances - people have a desire to hold money
i) transactions demand - for purchases
ii) precautionary demand - for unexpected expenses (like if your car's transmission dies)
iii) asset demand - holding money compared to holding stocks and bonds

b) asset demand - why hold money rather than assets
1) advantages - liquidity and no risk
2) disadvantages - you don't earn any interest or gains in asset prices

c) Demand for money, therefore, should be inversely related to asset prices. For simplicity, we will assume the only asset price is the nominal interest rate. The higher the interest rate, the lower the demand for money (asset demand for money).

II) Tools of Monetary Policy
a) Liquidity preference graph - top of page 426 (the book doesn't mention its name)
b) Money demand (described above) and Money supply (fixed by the fed
c) Tools of the central bank
1) Fed Funds rate - the most used. It is the rate banks charge eachother to borrow reserves. Sale of bonds by Fed (more money supply, lower interest rate). Fed buy's bonds (takes money out, money supply contracts, interest rates rise).
2) Discount rate - the rate the Fed charges to borrow reserves.
3) reserve requirement.

III) Effect of monetary policy on output - use aggregate demand and supply

IV) Monetary policy transmission mechanism
a) Page 435
b) The argument is that lower interest stimulate the economy through higher investment. But it also stimulates the economy through higher consumption
c) However, this is only a short run argument. In the long run expansionary monetary policy can only result in higher inflation.

V) Putting together fiscal and monetary policy with a realistic AD/AS curve
a) aggregate demand - still the same
b) long run aggregate supply - still the same
c) short run aggregate supply - upward sloping now (this is a partial concession to Keyne's. An upward sloping curve means prices rise, but in the short term the market does not fully adjust to the fiscal or monetary expansion.

VI) MV=PY and its relation to the long run
a) definitions
1) M = Money
2) V = Velocity
3) P = Prices
4) Y = output

The Fed cut

You can read the text of the statement accompaning the 25bps rate cut in the Fed funds rate here. Note how the bank hinted they will not be cutting rates at the next meeting.

"The Committee judges that, after this action, the upside risks to inflation roughly balance the downside risks to growth. The Committee will continue to assess the effects of financial and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth."

Info on Tues (10/30)

A number of students have called me to inquire about classes Tuesday night. I have called NCC and after talking to about 20 people I got information that there is some activities fair on Tues night that is causing classes to be cancelled during our time period. I was unaware of this (as apparently almost everyone else was), so our next class will be on Thurs. Quizzes will be due on Thursday.

Once you have your charter...

You probably want to join the Federal reserve system as a member bank.

Member Banks

The nation's banks can be divided into three types according to which governmental body charters them and whether or not they are members of the Federal Reserve System. Those chartered by the federal government (through the Office of the Comptroller of the Currency in the Department of the Treasury) are national banks, and by law are members of the System.
Banks chartered by the states are divided into those that are members of the System and those that are not. State-chartered banks are not required to join the System, but they may elect to become members if they meet the standards. As of June 30, 2006, there were a total of 7,480 commercial banks nationwide, of which 2,548 were members of the System. The Federal Deposit Insurance Corporation is responsible for supervising non-member banks.
Member banks must subscribe to stock in their regional Federal Reserve Bank in an amount equal to 3 percent of their capital and surplus. They receive a 6 percent annual dividend on their stock and may vote for Class A and Class B directors of the Reserve Bank. However the stock does not carry with it the control and financial interest that is normal for the common stock of a for-profit organization. It offers no opportunity for capital gain and may not be sold or pledged as collateral for loans. The stock is merely a legal obligation that goes along with membership.

How to start a bank

Click here to learn how to start your own bank.

(Note: this website should help you further understand how the banking system works).

Data and the Fed

The WSJ has a good summary of the latest economic data here. For the rare few without a subscription, here is what the article is saying.

The latest readings on the U.S. economy show continuing signs of weakness: Sales of newly built homes over the summer were weaker than previously estimated, September manufacturing was subdued, business inventories are mounting and the job market is displaying worrying signs of erosion.

How do we read this

1) Declining sales of newly built home suggest that construction of further new homes is unlikely to occur. This hurts GDP directly via a decline in residential investment within the GDP formula (C + I + G + NX). Further, since sales are slowing and inventory levels are high, prices are likely to come down and this can hurt GDP via consumption if people are no longer able to tap home equity to fund consumption

2) Rising business inventories suggest that businesses are not selling as many goods as they had anticipated. This points to a slowdown because they are unlikely to continue producing at current levels until inventories levels are back to where they want them

3) Although the latest NFP report suggests a decent labor market, data on "initial claims" has been rising as of late. Initial claims are initial unemployment claims people make when they lose their job so they can continue collecting unemployment.

How bad does this data look? Well, it certainly does not point to robust growth but the text of the article is not as bad as the first paragraph seems.

1) Sep new home sales rose a bit this month, with inventories declining modestly and pricing rising (editorial: although this is probably an illusion since the data is flawed in that it doesn't include cancelled contracts)

2) Business inventories were previously falling, so it may be the case that businesses are rebuilding their inventories back to the levels they want them at. Granted, this doesn't point to further build ups (which means no boost to GDP), but it "may" not mean a slowdown is in order. The strength in business investment suggests this is a possibility

3) Initial claims, while they are rising, are still not that high historically speaking and may be adversely impacted by the recent auto strikes, which temporarily boosted the claims.

How does the Fed respond to this? As you can see, the Fed has their work cut out for them since you can argue the imperfect data either way. However, it does look the downside risks to growth are real and potentially bad. Therefore, the current data is "bad enough" that another rate cut is likely as a hedge against a potential recession. As you will soon learn, monetary policy operates with a lag (between 6-18 months), before the full force of the rate cut can take place. If the recession risks are real, the Fed is going to want to get the rate cuts in the pipeline now because if they wait too long they will miss the recession (then again, on the other side of the coin, if no recession is coming the Fed can stoke inflation).

Now you know why they appoint these guys to 14 year terms.

Fed meeting next week

This is just a reminder that there is a Fed meeting scheduled for Oct 30-31st (the 31st will be the decision). You can read a schedule of all the meetings, plus the previous statements and minutes, here.

The consensus looks to be another 25bps to 50bps rate cut. The predictions market is pricing in a 25bps rate cut with about a 70% chance, a 50bps cut chance has about a 20% chance.

Remember that the Fed is worried about the recession in the housing market spilling over into other sections, causing an economy wide recession. In order to prevent this, the Fed is ordering the New York desk to purchase US government securities, which will increase the supply of money and push the Fed funds rate down. The fed fund rate, in turn, is supposed to influence other interest rates down and stimulate economic activity in the short run.

First bank of the United States

You can read about our very first federa bank here and here