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Fall 2017
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Economics 304
Homework #1 – A ride into reality!
Due Friday 1/27/17, at the beginning of class - no late papers accepted!
120 points total
Instructions: Please show all work or points will be taken off. Good luck!
1. (30 points total) In this first homework assignment, we are getting our ‘hands dirty’ to
get familiar with some of the major macroeconomic variables that we will be using and
working with throughout the semester. Our first chapter with ‘something to sink our teeth
into’ is chapter 3 in the packet and it is all about the factors of production, the labor
market, and of course, the production function. Major variables in this part of the
macroeconomy (i.e., the supply side of the economy) include, but certainly are not
limited to, employment (denoted N), real wages (denoted w = W/P where W = nominal
wage and P is the price index - typically the CPI or the PCE index) and real GDP
(denoted Y). When we move to the demand side of the economy we encounter many
more major macroeconomic variables including consumption (C), investment (I), and the
real interest rate (denoted r), among others. We are going to use FRED as our source of
data (many professional economists use this site, nice clean data!)1
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FRED stands for Federal Reserve Economic Data.- click Here for the FRED website
2
YOU MUST SHOW ALL WORK, IF YOU SIMPLY PUT THE ANSWER DOWN
YOU GET ZERO POINTS - I know for a fact that many students copy each others
homework!
Use the following link to answer part a) below
Click Here for data on the MW
PLEASE USE THE MW TABLE TO ANSWER PARTS a and b
a) (5 points) What is the rate of inflation between 1990 and 1991?
Price index 1990 3.80/X = 4.56 X = .833
Price index 1991 4.25/X = 4.90 X = .867
%ΔX = Π = 4.08%
b) (5 points) What would the nominal minimum wage have to be in 1987 to equal the real
purchasing power of the minimum wage in 2015?
price index in 1987.... 3.35/X = 4.63 .......X = .724
X'/.724 = 4.80.....3.475
Click Here for the latest report on PCE inflation
c) (5 points) The Fed targets the overall PCE rate of inflation as opposed to the core rate
of inflation --- given the latest PCE report, we notice that the core rate of PCE inflation is
higher than the over PCE rate of inflation. What is the difference between the core and
overall rate of PCE inflation, what are the latest numbers, and why is the overall rate of
inflation lower than the core rate of inflation? Click Here for some help. (use the Percent
change from month one year ago).
CORE EXCLUDES FOOD AND ENERGY SO IF FOOD AND ENERGY PRICES
ARE RISING LESS OR ARE FALLING, RELATIVE TO THE REST OF THE
ITEMS, THE OVER ALL WILL BE LOWER THAN CORE, AS IT IS NOW
OVERALL = 1.4%. CORE = 1.6%
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Use the article on the cost of living in PA to answer parts d) and e)
d) (5 points) Assuming that Allegheny County is the base county, what is the price index
in Centre county? In Chester county? Please take your answer to two decimal places.
Centre..........(25,300/28,700) x 100 = 88.15 = Centre
Chester.........(37,100/28,700) x 100 = 129.27 = Chester
e) (5 points) Assume that you received a job offer in Centre county for $65,000. What
offer would you need to receive in 1) Allegheny county and 2) Chester county to achieve
the same purchasing power as $65,000 in Centre county.
Allegheny.... $65,000/.8815 = X/1.00 = X = $73,738 = Allegheny County
Chester........ $65,000/.8815 = X/1.2927 = X = $95,321 = Chester County
f) (5 points) In May of 1986 I was making $12 per hour plastering in Orlando, FL. What
wage per hour would I need 30 years later, in May of 2016, to have the same purchasing
power as $12 per hour in May of 1986? (Click Here for the CPI).
12/1.09 = X/2.39403......X = $26.36 per hour
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2. (45 points) We discussed the port in the cruise ship analogy and the associated dual
mandate given to the Fed by Congress (click Here for more). We also mentioned that we
are doing quite well, at least statistically, with regard to achieving the dual mandate, the
best in many years.
In terms of achieving the dual mandate, we have a real goal and a nominal goal. One of
the real goals is for real GDP to be at potential GDP and/or real GDP growth to equal
potential GDP growth. You will need the following two links to answer this question:
Potential GDP
Real GDP
a)(5 points) Using the most recent data (2016:Q3), calculate the GDP gap as defined as:
[(Real GDP - Potential GDP)/ Potential GDP] x 100
16,726.970 = ACTUAL REAL GDP 2016 Q3
16,961 = POTENTIAL REAL GDP 2016 Q3
GAP = - 1.38 %
ONE MORE CORRECT ANSWER (POT GDP WAS CHANGED)
16,894.4 = POTENTIAL REAL GDP 2016 Q3
GAP = - 99 %
b)(5 points) Is your answer in part a) above consistent with the Fed raising interest rates,
why or why not? Hint: the term lag needs to be in your answer.
YES, GIVEN THE EFFECTIVENESS LAG, THE FED NEEDS TO ACT NOW
SINCE IT TAKES SO LONG (6 mos - 3 yrs)FOR MONETARY POLICY TO
HAVE IT DESIRED EFFECT - IF THEY WAIT, THE ECONOMY MIGHT
OVERHEAT.
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c) (5 points) Calculate what the GDP Gap was at the trough of the great recession - click
Here to identify when the trough was.
THE TROUGH WAS 2009 Q2
14355.558
15321.7
-6.305710202
14,355.558 = ACTUAL REAL GDP 2009 Q2
15,321.7 = POTENTIAL REAL GDP 2009 Q2
GAP = - 6.3057%
ONE MORE CORRECT ANSWER (POT GDP WAS CHANGED)
15,290.7 = POTENTIAL REAL GDP 2009 Q2
GAP = - 6.12%
d) (10 points) We also assess part of the dual mandate by comparing actual GDP growth
with potential GDP growth. For the most previous year....2015Q3 - 2016Q3, compare the
potential growth rate with the actual growth rate of real GDP. Are these two growth rates
consistent with the comments by John Williams and the title of article ‘We’re in a good
place’ - why or why not? (the article ‘We’re in a good place’ is posted on our home page)
Explain (this question is worth ten points).
POTENTIAL GROWTH: [(16,961.1 - 16,700.6)/16,700.6] x 100 = 1.56%
ACTUAL GROWTH: [(16,726.97 - 16,454.877)/16,454.877] x 100 = 1.65%
ONE MORE CORRECT ANSWER (POT GDP WAS CHANGED)
POTENTIAL GROWTH: [(16,894.4 - 16,623.3)/16,623.3] x 100 = 1.63%
WE'RE IN A GOOD PLACE IS THAT THERE ARE NO IMBALANCES IN THE
ECONOMY, WE ARE GROWING AT POTENTIAL
FROM ARTICLE
Interestingly enough, Williams thinks ideal gross domestic product growth should be
around 1.5 to 2 percent a year, which is the same modest rate the economy has been
growing under the Obama administration.
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e) (5 points) Let us go back exactly 20 years ago....compare the potential growth rate of
the economy to the actual growth rate of the economy for 1995Q3 - 1996Q3.
POTENTIAL GROWTH: [(10,786.3 - 10,452.1)/10,452.1] x 100 = 3.2%
ACTUAL GROWTH: [(10,626.78 - 10,208.77)/10,208.77] x 100 = 4.09%
ONE MORE CORRECT ANSWER (POT GDP WAS CHANGED)
POTENTIAL GROWTH: [(10,677.3 - 10,358.8)/10,358.8] x 100 = 3.07%
f) (10 points) Explain why there is such a difference between the potential growth rate of
the economy 20 years ago relative to the most recent potential growth rate. Give at least
two reasons. Be sure to refer to what exactly determines the potential growth rate of the
economy. Also, be sure you use information contained in the article 'The Fed’s Point
Man on Productivity' (this article is also posted on our home page).
LOWER PRODUCTIVITY GROWTH LOWERS THE POTENTIAL GROWTH
RATE OF ECONOMY AND SO DOES LOWER LABOR FORCE GROWTH
FROM ARTICLE:
Long-term economic expansion is the result of a growing workforce, investment in
capital such as technology and buildings, and then combining them in new ways to
boost efficiency—an element called “total factor productivity,” a key measure of the
economic contribution of innovation. Total factor productivity grew an average
1.8% a year from the end of 1995 through 2004, but growth has slowed since then to
an average 0.5% annually.
g) (5 points) According to John Williams in ‘We’re in a good place’, what are the keys to
putting our economy 'on a stronger, more sustainable path' ........same as.... increasing the
potential growth rate of the economy?
FROM ARTICLE:
We really need to think harder about what policies will put our overall economy on
a stronger, more sustainable path. Taxes, regulations, education, job training,
research and development, infrastructure spending — things that can have an effect
in the long run on productivity. Short run, we’re in a good shape. The critical issue
for our country are these longer-term issues, getting our workers to get the skills,
training and preparation to have success in the economy of the future.
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3. (45 points total)
a) ( 5 points) What is the current unemployment gap as defined as the actual
unemployment rate minus NAIRU? Use the links below to answer this question.
Unemployment Rate
NAIRU
4.7% - 4.8% = -.1%
or
4.7 - 4.74 = -.04%
b) (5 points) Give two reasons why the actual unemployment rate might be overstating
how good the conditions are in the labor market. In other words, give two reasons why
conditions in the labor market are not as rosy as the number suggests.
DISCOURAGED WORKERS AND UNDEREMPLOYMENT
c) (5 points) Using the links below, compare the average long run 'neutral' federal funds
rate projected by the Federal Open Market Committee (FOMC) in 2012 to the average
long run 'neutral' federal funds rate from the FOMC meeting in Dec. 2016. (to take
average - add up the individual votes and divide by the number of voters - use the dot
chart - the last chart on each pdf file)
2012 - FOMC projections
2016- FOMC projections
FOR 2012: [3 + 3.5 + 3.75 + 6(4) + 5(4.25) + 5(4.5)] / 19 = 4.1% = 2012
FOR 2016: [2.5 + 6(2.75) + 7(3) + 3.5 + 3.75) / 16 = 2.95% = 2016
d) (10 points) Given the Fed's target inflation rate is 2%, compare the projected 'neutral'
real interest rate from 2012 to that of 2016. What explains this difference (we did this in
class)?
FOR 2012: 4.1% - 2% = 2.1% = 2012
FOR 2016: 2.95% - 2% = .95% = 2016
e) (5 points) Using the links below, calculate the most recent one year ex-post real rate of
interest.
NOMINAL RATE IN DECEMBER OF 2015 = .65%
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INFLATION FROM DEC 2015 - DEC 2016 = 2.1%
EX-POST REAL RATE = .65% - 2.1% = - 1.45%
f) (5 points) Using the links below, calculate the most recent one year ex-ante real rate of
interest.
NOMINAL RATE IN DECEMBER OF 2016 = .87%
EXPECTED INFLATION FROM DEC 2016 - DEC 2017 = 2.2%
EX-ANTE REAL RATE = .87% - 2.2% = 1.33%
one year interest rate
CPI
inflation expectations
g) (10 points) Inflationary expectations are very important in Macro since they determine
in-part, the ex-ante real rate of interest. The bad news is that it is really difficult to get an
accurate measure of inflation expectations. Besides the Michigan Survey that you used in
part f), another method of capturing inflation expectations is to compare the yield on
Treasury Inflation Protected Securities (TIPS) to the yield on (regular) 10 - year
Government Securities (GS). Use the equation in the following link to answer the
following question:
Click Here for How to Use TIPS to Calculate Inflation Expectations
Calculate the implied inflation expectations in October 2016 to the implied inflation
expectations in December 2016. What could explain this change in inflation expectations
- be as specific as possible.
OCTOBER 2016: 1.76% = .10% + 1.66% = EXPECTED INFLATION OCTOBER
2016
DECEMBER 2016: 2.49% = .56% + 1.93% = EXPECTED INFLATION
DECEMBER 2016
INFLATION EXPECTATIONS ROSE SINCE TRUMP WON ELECTION AND
HE PROPOSES STIMULATIVE AGGREGATE DEMAND SIDE POLICIES INCREASE IN INFRASTRUCTURE SPENDING, LOWER CORPORATE TAX
RATES, ETC
10 YEAR TIPS
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10 YEAR GS
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