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Quiz 31 :

Supply-Side Policies

Quiz 31 :

Supply-Side Policies

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Login to www.cengagebrain.com and access the Global Economic Watch to do this exercise. Global Economic Watch Go to the Global Economic Crisis Resource Center and select Global Issues in Context. In the Basic Search box at the top of the page, enter the phrase "policy credibility." On the Results page, go to the News Section. Click on the link for the September 24, 2010, article "Research Conducted at Chongqing University Has Provided New Information About Economic Psychology." Does the research described support the importance of policy credibility?
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PHILLIPS CURVES Describe the different policy trade-offs implied by the short-run Phillips curve and the long-run Phillips curve. What forces shift the long-run Phillips curve?
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Philips curve:
Philips curve refers to the curve which shows the trade-off between inflation and unemployment. When there is a higher level of inflation, there will be a lower level of unemployment and vice versa. Therefore, inflation and unemployment have inverse relationship.
Trade-off Philips curve in the short run:
In the short run, the adjustment between the price and wages is relatively low. Therefore, when there is higher inflation than expected, then it increases the employment and output, which in turn decreases the level of unemployment and vice-versa.Trade-off Philips curve in the long run:
In the long run, price and wages are adjusted quickly. The increasing price leads to an increase in the wages. Therefore, there is no change in the output or unemployment level. Hence, the price increase leads to an increase in inflation rate and leaves the output as it is in the economy.
Shifts in the long-run Philips curve:
The Philips curve is determined by the potential level of output or at the point of natural rate of unemployment. If there is an increase in the factors of production such as raw materials and labor, then it leads to an increase in the production, which consequently shifts the long-run Philips curve rightward and vice-versa. Hence, change in the level of key resources shifts the long-run Philips curve.

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RATIONAL EXPECTATIONS Suppose that people in an election year believe that public officials are going to pursue expansionary policies to enhance their reelection prospects. How could such expectations put pressure on officials to pursue expansionary policies even if they hadn't planned to?
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Expansionary policy:
Expansionary policy refers to the macroeconomic policy which increases the money supply in the economy with the intention of bringing economic growth. The expansionary policy creates the inflationary situation in the economy.
Expansionary policy:
Expansionary policy increases the supply of money which helps the economy to grow. Even though expansionary policy creates the inflationary situation, inflationary situation can be bearable due to the economic growth at certain level. At the time of election, government implements the expansionary policy and gives assurance to people that their policy would take the country to a prosperous growth path. This would help to re-elect the political party.
Therefore, people expect the expansionary policy at the time of election. If the government fails to implement the expansionary policy, then it would lead to deflation and reduce the supply of money in to the economy, which in turn causes the economic growth to decline. This would lead to failure of the government in the election.
Hence, the government would implement the expansionary policy at the time of election.

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Login to www.cengagebrain.com and access the Global Economic Watch to do this exercise. Global Economic Watch Go to the Global Economic Crisis Resource Center and select Global Issues in Context. In the Basic Search box at the top of the page, enter the phrase "inflation target." Write a brief summary of one article published within the past three years.
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LONG-RUN PHILLIPS CURVE Suppose the economy is at point d on the long-run Phillips curve shown in Exhibit 6. If that inflation rate is unacceptably high, how can policy makers get the inflation rate down? Would rational expectations help or hinder their efforts? img
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Case Study: Active Versus Passive Presidential Candidates What were the main differences between candidates Bush and Clinton in the 1992 presidential campaign? Illustrate their ideas using the aggregate supply and demand model. Reference Case Study: Public Policy Active Versus Passive Presidential Candidates During the third quarter of 1990, after what at the time had become the longest peacetime economic expansion of the century, the U.S. economy slipped into a recession, triggered by Iraq's invasion of oil-rich Kuwait. Because of large federal deficits at the time, policy makers were reluctant to adopt discretionary fiscal policy to revive the economy. That task was left to monetary policy. The recession lasted only eight months, but the recovery was sluggish-so sluggish that unemployment continued to edge up in what was derisively called a "jobless recovery." That sluggish recovery was the economic backdrop for the presidential election of 1992 between Republican President George H. W. Bush and Democratic challenger Bill Clinton. Because monetary policy did not seem to be providing enough of a kick, was additional fiscal stimulus needed? With the federal budget deficit in 1992 already approaching $300 billion, a record amount to that point, would a higher deficit do more harm than good? Bush's biggest political liabilities during the campaign were the sluggish recovery and growing federal deficits; these were Clinton's biggest political assets. Clinton argued that (1) Bush had not done enough to revive the economy; (2) Bush and his predecessor, Ronald Reagan, were responsible for the sizable federal deficits; and (3) Bush could not be trusted because he broke his 1988 campaign pledge of "no new taxes" by signing a tax increase in 1990 to help cut federal deficits. Clinton promised to raise tax rates on the rich and cut them for the middle class. He also promised to create jobs through government spending that would "invest in America." Bush tried to remind voters that, technically, and the economy was growing again, so the recession was over. But that was a hard sell with unemployment averaging 7.6 percent during the six months leading up to the election (remember that the unemployment rate is a lagging indicator). Clinton saw a stronger role for government, and Bush saw a stronger role for the private sector. Clinton's approach was more active and Bush's more passive. In the end, high unemployment rates during the campaign made people more willing to gamble on Clinton. Apparently, during troubled times, an active policy has more voter appeal than a passive one. Ironically, the economy at the time was stronger than conveyed by the media and by challenger Clinton ("It's the economy, stupid" became Clinton's rallying cry). Real GDP in 1992 grew 3.4 percent, which would turn out to exceed the average annual growth rate during Clinton's first term. George W. Bush was not about to make the same mistake as his father. Shortly after taking office in 2001, he proposed the first of three tax cuts to stimulate a weak economy. These cuts, along with growth in government spending combined with the Fed's interest rate cuts for the greatest stimulus of aggregate demand to that point since World War II. Although the recession was over by the end of 2001, the unemployment rate continued to rise to a peak of 6.3 percent in June 2003. Then, as if on cue, in the final 12 months before the election of 2004, the economy added 2 million jobs. Despite an unpopular war in Iraq, the additional jobs helped Bush get reelected. img The 2008 presidential election was like no other in at least the last half century. President Bush was presiding over two unpopular wars, a financial crisis, and an economy sinking fast. But Bush was not on the ballot. Republican John McCain faced Democrat Barack Obama. Soon after the financial crisis of September 2008, the two candidates issued a joint statement supporting the TARP measure, the most significant legislative action prior to the November election-so, no policy difference between the two candidates on that one. But the candidates differed on other issues. For example, McCain favored extending the Bush tax cuts, which were set to expire in 2011. Obama would extend the Bush tax cuts but only for those making less than $250,000 a year. Obama proposed broad health care reform with more government regulations. McCain favored tax incentive to increase health coverage, saying he preferred "choices" to "mandates." Obama proposed creating millions of new jobs with "green energy" programs. Not McCain. More generally, Obama blamed Bush and, by association, McCain, for the financial crisis, arguing that they had stripped away regulations that would have prevented it (though the critical 1999 bank deregulation act was signed by President Clinton). A presidential poll taken a month before the election found that those whose top concern was the economy preferred Obama over McCain by 2 to 1. When the economy is in trouble, voters seem to support a more active approach. That's what they got.
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Case Study: Central Bank Independence and Price Stability One source of independence for the Fed is the term length for members of the Board of Governors. In the chapter before last, we learned that the Fed is a "money machine." Does this suggest another source of Fed independence from Congress?
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RATIONAL EXPECTATIONS Using an AD-AS diagram, illustrate the short-run effects on prices, output, and employment of an increase in the money supply that is correctly anticipated by the public. Assume that the economy is initially at potential output.
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ACTIVE VERSUS PASSIVE POLICY Contrast the active policy view of the behavior of wages and prices during a recessionary gap with the passive policy view.
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POLICY CREDIBILITY What is policy credibility and how is it relevant to the problem of reducing high inflation? How is credibility related to the time-inconsistency problem?
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RATIONALE FOR RULES Some economists call for predetermined rules to guide the actions of government policy makers. What are two contrasting rationales that have been given for such rules?
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THE ROLE OF EXPECTATIONS Some economists argue that only unanticipated increases in the money supply can affect real GDP. Explain why this may be the case.
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POTENTIAL GNP Why is it hard for policy makers to decide whether the economy is operating at its potential output level? Why is this uncertainty a problem?
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PROBLEMS WITH ACTIVE POLICY Use an AD-AS diagram to illustrate and explain the short-run and long-run effects on the economy of the following situation: Both the natural rate of unemployment and the actual rate of unemployment are 5 percent. However, the government believes that the natural rate of unemployment is 6 percent and that the economy is overheating. Therefore, it introduces a policy to reduce aggregate demand.
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ANTICIPATING MONETARY POLICY In 1995, the Fed began announcing its interest rate targets immediately following each meeting of the FOMC. Prior to that, observers were left to draw inferences about Fed policy based on the results of that policy. What is the value of this greater openness?
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ACTIVE POLICY Why do proponents of active policy recommend government intervention to close an expansionary gap?
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REVIEW OF POLICY PERSPECTIVES Why might an active policy approach be more politically popular than a passive approach, especially during a recession?
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ACTIVE VERSUS PASSIVE POLICY Discuss the role that each of the following plays in the debate between the active and passive approaches: a. The speed of adjustment of the nominal wage b. The speed of adjustment of expectations about inflation c. The existence of lags in policy creation and implementation d. Variability in the natural rate of unemployment over time
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ACTIVE VERSUS PASSIVE POLICY According to advocates of passive policy, what variable naturally adjusts in the labor market, shifting the short-run aggregate supply curve to restore unemployment to the natural rate? Why does the active policy approach assume that the short-run aggregate supply curve shifts leftward more easily and quickly than it shifts rightward?
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POLICY LAGS What lag in discretionary policy is described in each of the following statements? Why do long lags make discretionary policy less effective? a. The time from when the government determines that the economy is in recession until a tax cut is approved to reduce unemployment B) The time from when the money supply is increased until the resulting effect on the economy is felt C) The time from the start of a recession until the government identifies the existence and severity of the recession D) The time from when the Fed decides to reduce the money supply until the money supply actually declines
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