Chapter 21: Q 1. (page 566)
“When the stock market rises, investment spending is increasing.” Is this statement true, false, or uncertain? Explain your answer.
The statement is false.
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When the Federal Reserve reduces its policy interest rate, how, if at all, is the IS curve affected? Briefly explain.
Go to the St. Louis Federal Reserve FRED database, and find data on Personal Consumption Expenditures (PCEC), Personal Consumption Expenditures: Durable Goods (PCDG), Personal Consumption Expenditures: Nondurable Goods (PCND), and Personal Consumption Expenditures: Services (PCESV).
a. Using the most recent data, what percentage of total household expenditures is devoted to the consumption of goods (both durable and nondurable goods)? What percentage is devoted to services?
b. Given these data, which specific component of household expenditures would be most impacted by a reduction in overall household spending? Explain.
Go to the St. Louis Federal Reserve FRED database, and find data on Real Private Domestic Investment (GPDIC1), a measure of the real interest rate; the 10-year Treasury Inflation-Indexed Security, TIIS (FII10); and the spread between Baa corporate bonds and the 10-year U.S. treasury (BAA10YM), a measure of financial frictions. For (FII10) and (BAA10YM), convert the frequency setting to “quarterly,” and download the data into a spreadsheet. For each quarter, add the (FII10) and (BAA10YM) series to create ri , the real interest rate for investments for that quarter. Then calculate the change in both investment and ri as the change in each variable from the previous quarter.
a. For the eight most recent quarters of data available, calculate the change in investment from the previous quarter, and then calculate the average change over the eight most recent quarters.
b. Assume there is a one-quarter lag between movements in ri and changes in investment; in other words, if ri changes in the current quarter, it will affect investment in the next quarter. For the eight most recent lagged quarters of data available, calculate the onequarter-lagged average change in ri .
c. Take the ratio of your answer from part (a) divided by your answer from part (b). What does this value represent? Briefly explain.
d. Repeat parts (a) through (c) for the period 2008:Q3 to 2009:Q2. How do financial frictions help explain the behavior of investment during the financial crisis? How do the coefficients on investment compare between the current period and the financial crisis period? Briefly explain.
Consider an economy described by the following data:
mpc = 0.8
d = 0.35
x = 0.15
a. Derive an expression for the IS curve.
b. Assume that the Federal Reserve controls the interest rate and sets the interest rate at r = 4. What is the equilibrium level of output?
c. Suppose that a financial crisis begins and f increases to f = 3. What will happen to equilibrium output? If the Federal Reserve can set the interest rate, then at what level should the interest rate be set to keep output from changing?
d. Suppose the financial crisis causes f to increase as indicated in part (c) and also causes planned autonomous investment to decrease to I = \)1.1 trillion. Will the change in the interest rate implemented by the Federal Reserve in part (c) be effective in stabilizing output? If not, what additional monetary or fiscal policy changes could be implemented to stabilize output at the original equilibrium output level given in part (b)?
“Since inventories can be costly to hold, firms’ planned inventory investment should be zero, and firms should acquire inventory only through unplanned inventory
accumulation.” Is this statement true, false, or uncertain? Explain your answer
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