Question

I. You have studied the chapters on unemployment and business cycles. Please review those chapters before you answer this question

1. a) Find the time series data (quarterly or monthly) on the unemployment rate, inflation rate and real GDP growth in the U.S. from 1980 to 2005, and discuss whether the Okun’s Law is valid or not. Then, discuss whether the Phillips curve exists in the U.S. economy( you have to report your data source and or the website).

2. b) Which recession is most severe in terms of its depth and the duration of unemployment?

3. c) Why unemployment rises when the economic is recovering? what kinds of unemployment is it ?

II. Monetary policy will have different impact on the equilibrium rate of interest and GDP. Try to draw three different IS curves with different slopes and show

1. a) The different impact of the same easy money policy on interest rate and GDP in these different IS curves

2. b) Monetary policy is most effective under what conditions ( which IS curve). Why ?

3. c) What determine the slopes of IS curve. Review chapter 14 on sticky price and flexible price model to answer the percentage distribution of both types of firms ,i.e. s vs ( 1-s) under different IS curves( hint : refer to the equations on. P. 408 and p. 411 that

   P=EP+{( 1-s)/a/s} ( ( Y-Y bar) p. 408 Y= Y bar + alpha ( P-EP). P. 411

Year	Growth	Unemployment	Inflation	Business Cycle
1929	NA	3.2%	0.6%	Aug peak and Oct. market crash
1930	-8.5%	8.7%	-6.4%	Contraction
1931	-6.4%	15.9%	-9.3%	Contraction
1932	-12.9%	23.6%	-10.3%	Contraction
1933	-1.2%	24.9%	0.8%	New Deal and March trough
1934	10.8%	21.7%	1.5%	Expansion
1935	8.9%	20.1%	3%	Expansion
1936	12.9%	16.9%	1.4%	Expansion
1937	5.1%	14.3%	2.9%	May peak
1938	-3.3%	19%	-2.8%	June trough
1939	8%	17.2%	0%	Expansion and Dust Bowl ended
1940	8.8%	14.6%	0.7%
1941	17.7%	9.9%	9.9%	Expansion and WWII
1942	18.9%	4.7%	9%	Expansion
1943	17%	1.9%	3%	Expansion
1944	8%	1.2%	2.3%	Bretton-Woods
1945	-1%	1.9%	2.2%	Feb. peak, recession, Oct. trough
1946	-11.6%	3.9%	18.1%	Expansion and Fed cuts
1947	-1.1%	3.9%	8.8%	Marshall Plan and Cold War
1948	4.1%	4%	3%	Nov. peak
1949	-0.6%	6.6%	-2.1%	Oct. trough and NATO
1950	8.7%	4.3%	5.9%	Expansion and Korean War
1951	8%	3.1%	6%	Expansion
1952	4.1%	2.7%	0.8%	Expansion
1953	4.7%	4.5%	0.7%	War ended and July peak
1954	-0.6%	5%	-0.7%	May trough, Dow at 1929 level
1955	7.1%	4.2%	0.4%	Expansion
1956	2.1%	4.2%	3%	Expansion
1957	2.1%	5.2%	2.9%	Aug peak
1958	-0.7%	6.2%	1.8%	April trough
1959	6.9%	5.3%	1.7%	Fed raised rates
1960	2.6%	6.6%	1.4%	April peak and Fed cut
1961	2.6%	6%	0.7%	JFK spending and Feb. trough
1962	6.1%	5.5%	1.3%	Cuban Missile Crisis
1963	4.4%	5.5%	1.6%	LBJ spending, Fed raised rate
1964	5.8%	5%	1%	Fed raised rate
1965	6.5%	4%	1.9%	Vietnam War, Fed raised rate
1966	6.6%	3.8%	3.5%	Expansion, Fed raised rate
1967	2.7%	3.8%	3%	Expansion
1968	4.9%	3.4%	4.7%	Fed raised rate
1969	3.1%	3.5%	6.2%	Nixon, Fed raised rate, Dec. peak
1970	0.2%	6.1%	5.6%	Nov. trough, Fed cut rate
1971	3.3%	6%	3.3%	Expansion and Wage-price controls
1972	5.3%	5.2%	3.4%	Expansion
1973	5.6%	4.9%	8.7%	Vietnam War and gold standard ended, Nov. peak.
1974	-0.5%	7.2%	12.3%	Stagflation, Watergate, Fed raised rate
1975	-0.2%	8.2%	6.9%	March trough, Fed cut rate
1976	5.4%	7.8%	4.9%	Expansion, Fed cut rate
1977	4.6%	6.4%	6.7%	Carter
1978	5.5%	6%	9%	Fed raised rate
1979	3.2%	6%	13.3%	Fed raised then lowered rate
1980	-0.3%	7.2%	12.5%	Jan. peak, Fed raised rate, July trough
1981	2.5%	8.5%	8.9%	Reagan, Expansion peaked in July
1982	-1.8%	10.8%	3.8%	Nov. trough, Fed cut rate
1983	4.6%	8.3%	3.8%	Reagan spent on defense
1984	7.2%	7.3%	3.9%	Expansion
1985	4.2%	7%	3.8%	Expansion
1986	3.5%	6.6%	1.1%	Reagan cut taxes
1987	3.5%	5.7%	4.4%	Black Monday
1988	4.2%	5.3%	4.4%	Expansion, Fed raised rate
1989	3.7%	5.4%	4.6%	S&L Crisis
1990	1.9%	6.3%	6.1%	July peak
1991	-0.1%	7.3%	3.1%	March trough
1992	3.5%	7.4%	2.9%	Expansion, Fed cut rate
1993	2.8%	6.5%	2.7%	Expansion
1994	4%	5.5%	2.7%	Expansion
1995	2.7%	5.6%	2.5%	Fed raised rate
1996	3.8%	5.4%	3.3%	Fed cut rate
1997	4.4%	4.7%	1.7%	Fed raised rate
1998	4.5%	4.4%	1.6%	LTCM crisis
1999	4.8%	4%	2.7%	Expansion
2000	4.1%	3.9%	3.4%	Expansion
2001	1%	5.7%	1.6%	March peak, 9/11, and Nov. trough
2002	1.7%	6%	2.4%	Expansion
2003	2.9%	5.7%	1.9%	JGTRRA
2004	3.8%	5.4%	3.3%	Expansion
2005	3.5%	4.9%	3.4%	Expansion
2006	2.7%	4.4%	2.5%	Expansion

Answer 1

I.

a) Okun's Law provides a statistical relationship between the percentage change in Real GDP and the Unemployment. Employed workers help to produce goods and services and unemployed workers do not, increase in the unemployment rate should be associated with decreases in real GDP. This negative relationship between Unemployment and GDP is called Okun's Law.

From the websites US Department of Commerce and US Department of Labor, one can obtain the data source for the Percentage change in Labor Force and Percentage change in Real GDP. Plotting the latter on the Y-Axis and the former on the X-axis and drawing scatter plot shows the negative correlation between these variables. Increases in Unemployment tend to be associated with lower than normal growth in Real GDP. This gives the following relation as

Percentage change in Real GDP = 3.5% - 2*Change in the Unemployment Rate

Phillip's Curve explains the trade off between the Inflation rate and Unemployment rate.

The above figure shows a typical Phillip's Curve which is fitted for the US data obtained from the Bureau of Labor Statistics. This proves that Phillip's Curve exist in the short run.

b)The Great Recession of 2007-2009 is considered to be most severe in terms of its depth and unemployment rate. According to the Department of Labor, roughly 8.7 million jobs (about 7%) were shed from February 2008 to February 2010, and real GDP contracted by 4.2% between Q4 2007 and Q2 2009. In a two year span, the unemployment rate increased from 5% to 10% .

c) One of the stages of business cycle which follows a recession is an Economic Recovery. The economy would have incurred great losses from the recession period. To make up that, the companys and other firms would have to lay off and sack workers when they start to work again. Also, many firms would have shut down during the recession and it might be difficult for them to start once again soon after the recovery period starts. This type of unemployment is called Cyclical unemployment.

II.

Figure a has a relatively flatter IS Curve (IS1), Figure b has a less flatter IS Curve (IS2) and figure 3 has an inelastic IS Curve (IS3). With an expansionary monetary policy, with a relatively flatter curve (IS1), increase in output is more. Increase from Y1 to Y3 is greater than the increase from Y1 to Y2. Also, the fall in interest rate is less with a relatively flatter IS curve. Fall from r1 to r2 is less than the fall from r1 to r3.

b) Thus monetary policy is effective when the IS curve is more elastic or more flatter because the flatter the IS Curve, more will be the increase in GDP and less will be the fall in interest rate with an expansionary monetary policy.

c) The slope of the IS Curve is determined by the value of the multiplier and the investment response to interest rate. IS Curve equation can be given as

Y = KA - K(a1)i and corresponsingly slope can be given as

Change in i/Change in Y = -1/(K.a1), where K is the keynesian multiplier and a1 is the investment response to interest rate. Thus, greater the values of the multiplier or the investement response to interest rate, flatter will be the IS curve and alternatively with lower values, steeper will be the IS Curve.