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Name __________KEY__________________ last 4 PSU ID _______ Please check section that you are registered in: Section 001 - MWF: 10:10 - 11:00 AM : 10 Sparks Building __________ Section 002 - MWF: 11:15 AM - 12:05 PM : 121 Sparks Building ____________ Fall 2017 Chuderewicz - YOU MUST HAND IN HW IN THE SECTION YOU ARE REGISTERED FOR - NO EXCEPTIONS YOU MUST USE THIS AS A TEMPLATE – THAT IS – MAKE SPACE FOR YOUR ANSWERS BY HITTING ENTER (you certainly don’t need to type this assignment)– LEAVE THE QUESTIONS AS THEY ARE – AND PLEASE STAPLE! NOTEBOOK PAPER (OR ANY PAPER) STAPLED TO THE BACK IS NOT ACCEPTABLE (GETS A ZERO). ALSO, PLEASE PUT THE FIRST TWO LETTERS OF YOUR LAST NAME IN THE TOP RIGHT HAND CORNER OF THIS PAGE SO THAT WE CAN ALPHABETIZE THESE EASILY. THANKS IN ADVANCE! 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 1 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% 3 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 4 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. 5 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. 6 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. 7 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% 8 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 9 10 YEAR GS 10