Assignment:
1) A) Why do economists refer to the economy as "fully employed" even when there is measured unemployment as high as 4.5% -5% ? (Hint: begin your answer with a definition of full employment and then compare with the concept of natural rate of unemployment, NAIRU; what is it and why?). How do you relate the most recent unemployment rate (Look for Jan, 2012 data on unemployment rate in www.bls.gov) to your conclusion of this question indicating if the US economy is in a state of full employment? Feb 2012 unemployment data will be announced on March 9th.
B) Why would you expect the inflation rate to accelerate if the actual unemployment rate declined to a level lower than the "full employment" unemployment rate (NAIRU)? Explain your answer in a few sentences. What state of business cycles (such as recession, trough, recovery or boom) does the current US economy face, and why?
C) Draw an AS/AD diagram illustrating your answer to part (B) That is, draw an AS/AD diagram which shows what happens if strong growth in AD has pushed actual RGDP to a level above potential (full employment) RGDP. Be sure to label all lines and axes in your diagram clearly.
2) A) Suppose Jean Splicer, an investor, buys $100,000 of shares of stock in a diversified bundle of Bio-tech firms and exactly one year later sells those shares for $108,000. If the value of the CPI at the date of Jean's purchase was 160, and rose by the sale date one year later to 168, what was her real rate of return on this investment?
B) Why is it appropriate to use the CPI instead of the Gross Domestic Product Deflator in calculating the "real" rate of return in this example?
3) A) Suppose that as the economic recovery strengthened consumer expectations of annual inflation increased from 2% to 3.5 % and, at the same time, the expected real rate of return required to equate investor demand to the existing supply of 1 year Treasury notes increased from 1% to 1.5%. What would you expect to happen to the nominal yields on 1-year T-notes during the period over which these changes in inflation expectations and required real yields occurred? (Give a numerical answer if possible) Explain your reasoning.
B) Draw a supply/demand diagram of the US Treasury bond market to illustrate the effects on it of the developments cited in part A. Label your diagram clearly!
4) Go to the websites: ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt and ftp://ftp.bls.gov/pub/special.requests/lf/aat1.txt and https://bea.gov/national/index.htm#gdp (then click on "Current Dollar and Real GDP" link under Gross Domestic product) to collect the data on annual average data on CPI index, unemployment rates and real GDP (not the GDP in current dollars) data from year 2005 through 2011 (you need to collect the data from Y2005 to find the rates for Y2006). The first two url links from bls.gov will provide you the data for CPI index and unemployment rate respectively. The url from www.bea.gov will provide the RGDP data from GDP spreadsheet. Illustrate them in a table against the last 7 years and respond to the following two questions:
a. Calculate the changes in inflation rates, unemployment rates and the RGDP growth rates for the years from Year 2005 through 2011 and illustrate them in a new column next to each of the values of the three variables (an example of the table is given below).
Year Real GDP Growth rate of RGDP in % Unemployment Rate % Change in U rate in % CPI Indices Inflation rate in %
2005 12,623.0 - 5.10 - 195.3 -
2006 12,958.5 ? 4.6 ? 201.6 ?
2007 ? ? ? ? ? ?
2008 ? ? ? ? ? ?
2009 ? ? ? ? ? ?
2010 ? ? ? ? ? ?
2011 ? ? 8.9 ? ? ?
b. Based on those calculations, briefly describe the overall economic performance over the last 6 years (2006-2011) and critically predict about these three macroeconomic variables for 2012 and 2013.
Hint: While predicting the trend for 2012 (based on the growth rates and trend you estimated in the table above) and 2013, it is imperative to observe the most recent data on these three variables.
5) Since Fall of 2011, the price of oil has shown a sharp increase again as continuation steady rise in oil price attributed to the Arab Spring (the political uprising in the Middle Eastern and North African countries) started in the beginning of 2011. This upward trend of oil price has been further triggered by the recent tension in Iran on its Nuclear proliferation and the threat of blocking the oil export through the Harmuz Strait. Accordingly, many analysts in the energy field have predicted the likelihood of rise in oil price up to $5/gallon by coming summer in the US market.
Given the circumstances above about the oil market, draw an AS/AD diagram, which shows the effect on the US macro-economy of expected oil price @ $130+ per barrel versus the oil price at $100+ per barrel (in the beginning of 2012). In your explanation in words about the diagram, you must clearly explain the connection between changes in oil price and the fluctuations in macroeconomic fundamentals in the US economy. Then show the impact of continuous rise oil price on the US economy by using the AD-AS model during the recovery period of the economy from its great recession of 2008. (The most recent price of crude oil is about $104+/barrel).
Label your diagram clearly and explain how higher oil prices impact either AS, AD or both.
Finally, explain why sharp rise in oil prices might not necessarily have negative or positive impact on the US equity markets even at the current trend of volatile oil prices.
6) Which of the following changes to fiscal stimulus package of 2009 for $862 billion (under the bill called American Recovery and Reinvestment Act of 2009) would have a larger overall impact on AD? Explain your answer in a paragraph or two with credible logics and analysis. 4 pts
A) A program of tax rebates, distributed uniformly across the population of those filing tax returns, amounting to $862 billion in total rebates.
Alternatively,
B) An $862 billion increase in federal government spending on repairs to highways and bridges, including other related infrastructure.
Hint: You may also use the AD-AS diagram as part of your analysis, but not required. However, explaining the answer with the concept of multiplier effects for these two alternative options is the right way to address this question.
Note: Note: The original bill was passed with its initial amount of $787 billion for 2 years recovery plan, which was subsequently increased to $862 billion. The $862 B was exhausted long before the end of 2011.
The most recent crisis of skyrocketing budget deficit and the public debt of the US government has been the source of continuous economic uncertainty in the recovery process of the Great Recession of 2008. Such uncertainty and the fear of potential default of paying the US debt installments have led the credit agency S&P 500 to downgrade the US bond ratings from AAA status to AA+ for the first time in US history.
From your understanding about the theories and applications of bond market in this class, critically but briefly analyze the reasons why the effect of the downgrade of US Treasury bond ratings on interest rates was not the way one would predict from the basic theories of the bond market. In another words, critically analyze the reasons why the short term yield and interest rates did not increase after the downgrade of US Treasury securities by S&P 500.