A) What is the level of domestic spending in Q4:2018? What was the growth rate for domestic spending over the four quarters of 2018?

Transcription

1 Question I Assume U.S. real GDP, Q4:2017, equals $15 trillion, U.S. NX = $-0.5 trillion Assume U.S. real GDP growth rate, w/no stimulus, equals 2%: 1.5 percentage point contribution from productivity, 0.5 pp from growth in the labor force. Assume U.S. growth rate for domestic spending (real GDP-NX), if no stimulus is enacted, is also 2% Assume U = 5%, π = 2% and assume U = 5%, end-of-year 2018, if there is no stimulus. Suppose Donald Trump enacts a $200 billion tax cut and $100 billion spending increase on infrastructure. Assume a 1.5 multiplier on the combined effects on domestic spending, from Trump fiscal policy changes. Assume the Trump policies and the multipliers drive domestic spending. Finally, assume the effects of the Trump policy, enacted end of 2017, occur over the four quarters of A) What is the level of domestic spending in Q4:2018? What was the growth rate for domestic spending over the four quarters of 2018? B) Suppose USA interest rates jump, with rest-of-world interest rates steady. Suppose rest-ofworld spending growth stays soft, rising at 2%. a. What do you think happen to the value of the dollar? b. Given the dollar s move and the different spending growth rates what do you think happens to USA NX? Briefly explain. C) Suppose USA NX deficit rises to $-0.7 trillion. What is the level and the growth rate for USA real GDP, in Q4:2018?

2 D) Two economists, Freddy and Betty, both forecast the new level for real GDP correctly. However, Freddy predicted the unemployment rate would fall materially while Betty predicted it would stay the same. Which economist assumed that labor productivity and the labor force grew faster? Explain E) Will the Fed tighten more if Freddy is right or Betty is right? Explain.

3 Question II Assume the U.S. economy can grow at 2.5% per year. Assume the Federal Reserve thinks the ideal inflation rate is 2% Assume the natural rate of unemployment is 5% Assume the Fed thinks r*, the real interest rate at which the economy neither speeds up nor slows down, is 2% a) In 2017, President Trump replaces Janet Yellen with a Donald Trump Jr., a monetarist. His approach to monetary policy comes from the quantity theory of money. At what rate will he aim to increase the money supply? b) By 2018 inflation is running high and President Trump denounces this policy as a complete and utter disaster. What false assumption made by Donald Trump Jnr. led to the policy not resulting in steady growth and inflation. c) President Trump now replaces his son with a tremendous guy from Stanford whose monetary policy rule has helped guide central banks for many decades. Who is he, and write down his rule. d) At this point, unemployment is 6.5% and inflation is 10%. If the new chair follows his own rule, what will the fed funds rate be?

4 e) After a year of this policy, inflation has been bought back under control and is at the desired level of 2%. However, unemployment has risen to 11%. What fed funds rate does the rule now suggest? Why is this a problem? f) The Fed decides it needs to do Quantitative Easing to help stimulate the economy. However, rather than buy unproductive government bonds, they decide to do Quantitative Easing in the corporate sector. Using a three quadrant diagram explain why this will, or will not, work according to the extended loanable funds model. g) Especially in light of President Trump s large business interests, why might some critics worry about this approach?

5 h) Explaining why he thinks Quantitative Easing in the government bond market does not work, the Chair of the Federal Reserve says the demand curve for government bonds is inelastic. Using a three quadrant diagram again, explain how QE in the government bond market can work despite an inelastic demand curve for government borrowing.

6 Question III India s Nominal GDP in 2015 = 125 trillion INR (Indian Rupees) U.S. Nominal GDP in 2015 = $18 trillion Exchange rate: 1$ buys 70 INR A typical basket of goods that costs $100 in the US will cost 3,500 INR in India Population India = 1.25 billion Population US = 320 million a) What is the GDP/capita in India and the US in their local currencies? b) What is the ratio of GDP/capita in the US compared to that of India using the market exchange rate? c) What is the ratio of GDP/capita in the US compared to that of India using Purchasing Power Parity? d) Which of these is more likely relevant to the World Bank when thinking about global poverty? Why? On November , Prime Minister Modi announced a demonetization in India, requiring all 500 and 1000 INR banknotes to be deposited at a bank by 30 December This has shaken confidence in the currency and many Indian households have looked to exchange their rupees for foreign assets.

7 e) What happened to the Indian demand for USD? f) What happened to the value of the Indian Rupee? g) Draw a chart showing the shifts in supply and demand in the INR/USD foreign exchange market. h) Suppose the Central Bank of India wants to prevent a change in the exchange rate. Reproduce your graph above, and add in the action that the Central Bank of India could take in order to prevent a change in the exchange rate.

8 Question IV Here is some data for the US in Debt/GDP ratio: 70% Nominal GDP: $18 trillion Government Deficit: $600 billion Average US government nominal borrowing rate: 2% Expected inflation: 2% Expected growth: 2.5% a) How many dollars would you expect the government to have to pay in interest on its debt this year? b) What will the total dollar size of the debt be in 2017? What will the Debt/GDP ratio be? The CBO (Congressional Budget Office) is often tasked with looking at how various policy proposals will effect the government debt and deficit. Suppose you are in the CBO at the beginning of 2016 and are analyzing a large tax cut which will increase the deficit by $200 billion per year. There is a debate about whether the CBO should use dynamic scoring for tax cuts in which they take into account projected growth changes when forecasting the government debt. c) Your first task is to forecast the Debt/GDP ratio for the following year without using dynamic scoring. Has the policy increased or decreased Debt/GDP next year according to this analysis? d) Some economists tell you that the tax cut is projected to increase growth from 2.5% to 5% in the coming year. Following this advice, and using the dynamic scoring method, forecast the Debt/GDP ratio for next year. Has the policy increased or decreased Debt/GDP next year according to this analysis?

9 e) Does the conclusion from d) suggest the US is beyond the point of maximum tax revenue on the Laffer curve? Explain. Question V US Current Account Deficit: $400 billion Foreign Assets owned by US: $25 trillion Rate of return earned on these foreign assets: 3.1% US Assets owned by foreigners: $33 trillion Rate of return earned by these US assets: 1.8% a) What is the Net Foreign Asset position of the US b) How much do income and payments arising from the Net Foreign Asset position add to the US current account deficit? What would the deficit be if the Net Foreign Asset position was 0? c) Will the Net Foreign Asset position rise or fall in the next year? By how much?