Chapter 18 Keynesian Monetarist Real Business Cycle And Great

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Solution

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1. Since the crash of its stock market in 1989, the Japanese economy has seen little eco-

nomic growth and some deflation. The accompanying table from the Organization for

Economic Cooperation and Development (OECD) shows some key macroeconomic

data for Japan for 1991 (a “normal” year) and 1995–2003.

a. From the data, determine the type of policies Japan’s policy makers undertook at

that time to promote growth.

b. We can safely consider a short-term interest rate that is less than 0.1% to effec-

1. a. From the annual real GDP growth rate, we can see the slow growth of the Japanese

economy: the economy actually contracted in 1998 and 2002, with minimal

growth in 1999 and 2001. We can also see that policy makers used expansionary

monetary policy to spur the economy: short-term interest rates fell from 7.38% in

Government

Real GDP Government budget

annual Short-term debt deficit

growth interest (percent (percent

Year rate rate of GDP) of GDP)

1991 3.4% 7.38% 64.8% −1.81%

1995 1.9 1.23 87.1 4.71

1996 3.4 0.59 93.9 5.07

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Solution

2. The National Bureau of Economic Research (NBER) maintains the official chronology

of past U.S. business cycles. Go to its website at www.nber.org/cycles/cyclesmain.html

to answer the following questions.

a. How many business cycles have occurred since the end of World War II in 1945?

Committee, and what was it?

2. a. Answers will vary. But as of December 2014, there had been 11 business cycles

since the end of 1945. This includes the recession that began in December 2007

and, at the time of writing, still continued.

b. As of December 2014, the average duration of a business cycle for the period

3. The fall of its military rival, the Soviet Union, in 1989 allowed the United States to

significantly reduce its defense spending in subsequent years. Using the data in the

following table from the Economic Report of the President, replicate Figure 18-3

for the 1990–2000 period. Given the strong economic growth in the United States

during the late 1990s, why would a Keynesian see the reduction in defense

spending during the 1990s as a good thing?

Budget deficit Unemployment

Year (percent of GDP) rate

1990 3.9% 5.6%

1991 4.5 6.8

1992 4.7 7.5

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Solution

3. The accompanying diagram replicates Figure 18-3 for the 1990–2000 period. It was

fortunate that defense spending fell and the budget deficit declined during this period

because additional spending at a time of strong growth (and low unemployment

rates) would likely have created inflationary pressure.

Unemployment rate,

budget deficit

4. In the modern world, central banks are free to increase or reduce the money supply

as they see fit. However, some people harken back to the “good old days” of the gold

4. a. For prices to remain stable when the economy was expanding and the velocity of

5. The chapter explains that Kenneth Rogoff proclaimed Richard Nixon “the all – time

hero of political business cycles.” Using the table of data below from the Economic

Report of the President, explain why Nixon may have earned that title. (Note: Nixon

entered office in January 1969 and was reelected in November 1972. He resigned in

August 1974.)

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Government

Government receipts Government spending budget balance 3-month Treasury

Year (billions of dollars) (billions of dollars) (billions of dollars) M1 growth M2 growth bill rate

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Solution

5. The data indicate that President Nixon may have used fiscal and monetary policy to

aid his reelection efforts. From his first year in office, 1969, to his reelection year,

6. The economy of Albernia is facing a recessionary gap, and the leader of that nation

calls together five of its best economists representing the classical, Keynesian, mon-

etarist, real business cycle, and Great Moderation consensus views of the macroecon-

omy. Explain what policies each economist would recommend and why.

6. In response to a recessionary gap in Albernia, the economists representing the differ–

ent views of the macroeconomy would make the following suggestions.

Classical: Do nothing. The recessionary gap will exist only in the short run, and the

only focus for policy makers is the long run.

7. Which of the following policy recommendations are consistent with the classical,

Keynesian, monetarist, and/or Great Moderation consensus views of the macroeconomy?

a. Since the long – run growth of GDP is 2%, the money supply should grow at 2%.

7. a. Monetarists would support such a policy; they believe in a monetary policy rule

that allows the money supply to grow at the same rate as GDP. Since classical

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Solution

b. Classical economists would see the inflationary pressure as a short-run problem

and would not advocate any policy; their view would be that the inflationary pres-

c. Classical economists would see a recessionary gap as a short-run problem and

would not advocate any policy; their view would be that the recessionary gap will

not exist in the long run. Monetarists would also be reluctant to endorse a short-

run discretionary monetary policy because they believe it will make the economy

worse. Expansionary monetary policy, such as an increase in the money supply,

would be recommended by Keynesians and by followers of the Great Moderation

consensus if the economy is not suffering from a liquidity trap.

8. Using a graph like Figure 18-4, show how a monetarist can argue that a contrac-

tionary fiscal policy need not lead to a fall in real GDP given a fixed money supply.

Explain.

8. As you can see in the accompanying figure, contractionary fiscal policy shifts the

aggregate demand curve leftward, from AD1 to AD2, in panel (a). Correspondingly,

there is a decrease in money demand, and the money demand curve shifts leftward,

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Solution

9. Monetarists believed for a period of time that the velocity of money was stable within

a country. However, with financial innovation, the velocity began shifting around

a. Calculate the velocity of money for each of the countries. The accompanying table

shows GDP per capita for each of these countries in 2013 in U.S. dollars.

Nominal GDP per capita

Country (U.S. dollars)

Egypt $3,225

South Korea 24,328

b. Rank the countries in descending order of per capita income and velocity of

money. Do wealthy countries or poor countries tend to “turn over” their money

9. a. The velocity of money is defined as nominal GDP divided by the quantity of

money. For example, the velocity of money in Egypt is 1,753/431 = 4.1. The velocity

of money for each of the countries is shown in the accompanying table.

Country Velocity of money

Egypt 4.1

South Korea 2.8

b. Rank in descending order of velocity: South Korea, United States, Thailand, Kenya,

Egypt, India. Rank in descending order of per capita income: United States, South

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