# Macroeconomic Analysis

| June 30, 2015

Macroeconomic Analysis, Eco 336

Summer 2015 Assignment 2

Instructions:

1. All work must be typewritten
2. Where numerical computations are needed, show all your work in detail.
3. Use Excel to answer questions 2 and 3. Copy and paste the results onto your Word document
4. Failure to follow these instructions will result in loss of points
1. (30 points) Use the IS-MP- Phillips curve model to graphically discuss the effects of the following events on the U.S. real GDP gap ( ), real interest rates, employment, and inflation rate (. Draw a separate diagram for each case, label your diagrams and clearly show the direction of changes in your model. Start by assuming that the economy is producing at potential output. In other words, the output gap is zero.
1. The Fed conducts an open market purchase of government securities in an attempt to reduce the federal funds rate
2. In an attempt to stimulate the economy, government increases investment tax credit to increase the desired investment spending.
3. The recent military unrest in Syria spreads to neighboring countries, and the increasing anxiety in the market causes oil prices to jump to \$200 per barrel.
4. President Obama is reelected for a second term as the president of the United States. In response to pressure from Democrats, the president increases government spending in an attempt to increase economic activity and employment.
5. The recent growing banking crisis in Cyprus spreads to other Euro-zone countries suffering from high government debt. This increases uncertainty in the European economies.
6. New discoveries of oil in the United States, Canada, and Mexico, result in reduced the world oil prices

1. (Excel exercise) (30 points) Suppose we are interested in estimating the short-run Phillips curve and the Okun’s law equation for the United States for the period 1962-2012.

The expectations-augmented Phillips curve is:

πt = πte + b ( ) – st and the Okun’s law is  Ut – UN = – β ( ) or = a + c DUt

Where πt = inflation in year t, πte = expected inflation rate in year t, = GDP gap, defined as

= , YP = real potential GDP, st = the supply shock, DY = growth rate of real GDP, and

DU = change in unemployment rate, i.e. DUt = Ut – U t-1

If expectations are formed adaptively, then πte = πt -1 and the Phillips curve relationship can be

written as:   πt = πt-1 + b ( ) – st. The supply shock is measured as the change in oil prices,

DPOIL.

1. Use Excel to estimate the Phillips curve: πt = a1 + a2 πt -1 + a3 GAP + a4 DPOIL

Where GAP = , DPOIL is the annual percentage change in oil prices, i.e.

DPOIL = ( )*100

1. Comment on the estimated equation and interpret the estimated slope coefficients a2 , a3

and a4 in the Phillips curve equation.

The data for this question is available on the course Moodle.

Data for question 2

 Year RGDP POTRGDP U UN CPI POIL FFR GAP DPOIL π t π t-1 DY U cyclical 1961 2896.875 2969.797 6.69 5.51 29.90 2.97 1.96 -2.455 0.000 1.07 1.49 \$2.330 1.18 1962 3072.375 3092.071 5.57 5.51 30.25 2.97 2.71 -0.637 0.000 1.18 1.07 \$6.058 0.06 1963 3206.7 3220.911 5.64 5.55 30.63 2.97 3.18 -0.441 0.000 1.26 1.18 \$4.372 0.10 1964 3392.325 3356.072 5.16 5.59 31.04 2.95 3.50 1.080 -0.842 1.32 1.26 \$5.789 -0.44 1965 3610.15 3500.669 4.51 5.67 31.53 2.92 4.07 3.127 -0.849 1.58 1.32 \$6.421 -1.17 1966 3845.325 3660.532 3.79 5.77 32.47 2.94 5.11 5.048 0.571 2.99 1.58 \$6.514 -1.97 1967 3942.525 3832.379 3.84 5.78 33.38 3.03 4.22 2.874 3.065 2.78 2.99 \$2.528 -1.94 1968 4133.4 4002.028 3.56 5.79 34.79 3.07 5.66 3.283 1.432 4.24 2.78 \$4.841 -2.23 1969 4258.15 4166.138 3.49 5.84 36.68 3.30 8.20 2.209 7.329 5.44 4.24 \$3.018 -2.35 1970 4266.3 4316.605 4.98 5.89 38.84 3.35 7.18 -1.165 1.694 5.88 5.44 \$0.191 -0.91 1971 4409.525 4452.433 5.95 5.94 40.48 3.56 4.66 -0.964 6.242 4.23 5.88 \$3.357 0.01 1972 4643.75 4588.152 5.60 6.03 41.81 3.56 4.43 1.212 0.000 3.27 4.23 \$5.312 -0.43 1973 4912.825 4739.781 4.86 6.13 44.43 3.87 8.73 3.651 8.778 6.26 3.27 \$5.794 -1.27 1974 4885.75 4914.150 5.64 6.17 49.32 10.37 10.50 -0.578 167.850 11.01 6.26 -\$0.551 -0.53 1975 4875.35 5090.220 8.48 6.17 53.83 11.16 5.82 -4.221 7.592 9.14 11.01 -\$0.213 2.30 1976 5136.925 5253.548 7.70 6.20 56.93 12.65 5.05 -2.220 13.306 5.77 9.14 \$5.365 1.50 1977 5373.075 5424.096 7.05 6.23 60.62 14.30 5.54 -0.941 13.055 6.47 5.77 \$4.597 0.82 1978 5672.775 5615.916 6.07 6.27 65.24 14.85 7.93 1.012 3.876 7.63 6.47 \$5.578 -0.20 1979 5850.05 5814.190 5.85 6.25 72.58 22.40 11.19 0.617 50.870 11.25 7.63 \$3.125 -0.40 1980 5833.975 5968.346 7.18 6.21 82.38 37.38 13.36 -2.251 66.822 13.50 11.25 -\$0.275 0.96 1981 5982.075 6102.885 7.62 6.17 90.93 36.67 16.38 -1.980 -1.895 10.38 13.50 \$2.539 1.45 1982 5865.925 6277.857 9.71 6.11 96.53 33.64 12.26 -6.562 -8.266 6.16 10.38 -\$1.942 3.60 1983 6130.925 6463.778 9.60 6.07 99.58 30.40 9.09 -5.150 -9.635 3.16 6.16 \$4.518 3.53 1984 6571.525 6659.666 7.51 6.04 103.93 29.28 10.23 -1.323 -3.679 4.37 3.16 \$7.187 1.46 1985 6843.4 6881.603 7.19 6.02 107.60 27.97 8.10 -0.555 -4.452 3.53 4.37 \$4.137 1.17 1986 7080.5 7108.782 7.00 5.99 109.69 15.04 6.81 -0.398 -46.232 1.94 3.53 \$3.465 1.01 1987 7307.05 7331.295 6.18 5.97 113.62 19.16 6.66 -0.331 27.409 3.58 1.94 \$3.200 0.21 1988 7607.4 7555.496 5.49 5.93 118.28 15.96 7.57 0.687 -16.707 4.10 3.58 \$4.110 -0.44 1989 7879.175 7785.143 5.26 5.90 123.94 19.59 9.22 1.208 22.737 4.79 4.10 \$3.573 -0.64 1990 8027.025 8019.412 5.62 5.86 130.66 24.49 8.10 0.095 25.024 5.42 4.79 \$1.876 -0.25 1991 8008.325 8247.336 6.85 5.78 136.17 21.48 5.69 -2.898 -12.292 4.22 5.42 -\$0.233 1.07 1992 8280.025 8468.272 7.49 5.66 140.31 20.56 3.52 -2.223 -4.283 3.04 4.22 \$3.393 1.83 1993 8516.175 8700.050 6.91 5.53 144.48 18.46 3.02 -2.113 -10.229 2.97 3.04 \$2.852 1.38 1994 8863.125 8951.904 6.10 5.40 148.23 17.19 4.20 -0.992 -6.898 2.60 2.97 \$4.074 0.70 1995 9085.975 9222.853 5.59 5.29 152.38 18.43 5.84 -1.484 7.225 2.81 2.60 \$2.514 0.30 1996 9425.85 9513.340 5.41 5.20 156.86 22.15 5.30 -0.920 20.223 2.94 2.81 \$3.741 0.21 1997 9845.925 9825.432 4.94 5.12 160.53 20.60 5.46 0.209 -7.019 2.34 2.94 \$4.457 -0.18 1998 10274.75 10165.205 4.50 5.07 163.01 14.39 5.35 1.078 -30.151 1.55 2.34 \$4.355 -0.57 1999 10770.625 10530.040 4.22 5.03 166.58 19.25 4.97 2.285 33.801 2.19 1.55 \$4.826 -0.81 2000 11216.425 10913.003 3.97 5.01 172.19 30.30 6.24 2.780 57.380 3.37 2.19 \$4.139 -1.04 2001 11337.475 11289.728 4.74 5.00 177.04 25.92 3.89 0.423 -14.437 2.82 3.37 \$1.079 -0.26 2002 11543.1 11626.243 5.78 5.00 179.87 26.10 1.67 -0.715 0.669 1.60 2.82 \$1.814 0.78 2003 11836.425 11934.415 5.99 5.00 184.00 31.14 1.13 -0.821 19.322 2.30 1.60 \$2.541 0.99 2004 12246.925 12230.445 5.54 5.00 188.91 41.44 1.35 0.135 33.071 2.67 2.30 \$3.468 0.54 2005 12622.95 12515.820 5.08 5.00 195.27 56.47 3.21 0.856 36.265 3.37 2.67 \$3.070 0.08 2006 12958.475 12808.620 4.61 5.00 201.56 66.10 4.96 1.170 17.068 3.22 3.37 \$2.658 -0.39 2007 13206.375 13118.778 4.62 5.00 207.35 72.36 5.02 0.668 9.469 2.87 3.22 \$1.913 -0.39 2008 13161.925 13423.598 5.80 5.07 215.26 99.57 1.93 -1.949 37.595 3.81 2.87 -\$0.337 0.73 2009 12757.95 13681.898 9.28 5.23 214.57 61.69 0.16 -6.753 -38.039 -0.32 3.81 -\$3.069 4.06 2010 13062.975 13889.318 9.63 5.43 218.09 79.43 0.18 -5.949 28.746 1.64 -0.32 \$2.391 4.20 2011 13299.1 14114.633 8.93 5.50 224.94 95.08 0.10 -5.778 19.702 3.14 1.64 \$1.808 3.43 2012 13591.05 14365.913 8.08 5.50 229.61 94.20 0.14 -5.394 -0.921 2.08 3.14 \$2.195 2.58

Where:

POTRGDP= Potential real GDP (billions of \$)

GDP = Nominal GDP (billions of \$);   Ut= Unemployment rate (%) in year t; UN = Natural unemployment rate (%); (Ut – UN) = Cyclical unemployment rate (%)

POIL = Price per barrel of oil (West Texas Intermediate); CPI = Consumer price index

Population = US population (1000)

π = Inflation rate, defined as -1)*100; πt -1 = lagged value of inflation rate

GAP = GDP gap, defined as =      DPOIL = Percentage change in price of oil, as a proxy for supply shocks, defined as -1)*100

1. (20 points) (Excel exercise) Use the quarterly data for the United States for the period 1959-2012, to plot the federal funds rate (FFR), and the difference between the unemployment rate and the natural rate of unemployment (U – UN), measuring cyclical unemployment rate.
1. What do you observe, and how do you explain this?
2. What is the correlation coefficient between federal funds rate and cyclical unemployment rate (U – UN)?

Data for this question is available on the course Moodle under “U.S. Macroeconomic data-Quarterly 1959-2012”

1. (20 points) Using data from the St. Louis Federal Reserve: (http://research.stlouisfed.org/fred2) examine the relationship between financial market risk and recessions in the United States. One way to measure the degree of risk in financial markets is to look at the TED spread, which is the difference between the 3-month London Interbank Offered Rate (LIBOR) (USD3MTD156N) and the 3-month U.S. Treasury bill (DGS3MO). The higher the value of the TED spread the more expensive it is for banks to borrow relative to what it costs the U.S. government to borrow, which means financial markets have become riskier.

The dates of U.S. recessions can be found from the National Bureau of Economic Research’s website at: http://www.nber.org/cycles/cyclesmain.html

1. Calculate and graph the TED spread from 1986 to the present
2. The United States experienced a severe recession from December 2007 to June 2009. What happened to TED spread during the 2007-2009 recession? Did the TED spread begin to rise before or after the recession began? What is the significance of this?
3. How does the behavior of TED spread during the 2007-2009 recession compare to its behavior during earlier recessions? What does this suggest about financial markets during the 2007-2009 recession?

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