E Problem Set 5

E.1 Gregory N. Mankiw - NYT - Nov 30, 2008

This exercise is based on the following New York Times article, which Gregory N. Mankiw wrote a bit more than 2 months after the bankruptcy of Lehman Brothers (to which we shall come back at the end of the class). The New York Times articles are gated after you have read your monthly quota, but archives are available through UCLA on ProQuest:

Mankiw, N. Gregory. What would Keynes have done? New York Times, November 30, 2008

  1. According to Gregory N. Mankiw, which factors contributed to hold back consumption? Can you interpret these factors in terms of changes in \(c_0\)?

  2. Gregory N. Mankiw mentions the “paradox of thrift”. Which model that we saw in the class makes most sense of his explanations?

  3. Concerning saving, one of the arguments that Gregory N. Mankiw makes is more neoclassical. Which one is it?

  4. What is Gregory N. Mankiw most concerned about though?

E.2 Readings - Multiplier

  1. Robert Barro. Keynes Is Still Dead. Wall Street Journal. October 29, 1992. Robert Barro compares the idea of the Keynesian multiplier to an oft-caricatured version of supply-side economics. What is this caricature? Under what conditions is a Keynesian multiplier “self-financing”?

  2. Mankiw, N. Gregory. What would Keynes have done? New York Times, November 30, 2008. According to Greg Mankiw, which factors were contributing to hold back consumption in November 2008? Is Greg Mankiw mostly neoclassical or Keynesian in his approach to investment spending? Justify your answer.

  3. Robert J. Barro, Government Spending Is No Free Lunch, Wall Street Journal, January 22, 2009. What is Robert J. Barro’s interpretation of Keynesian economics? Even if one agrees with Robert Barro’s view of government spending, what would be an alternative way to boost aggregate demand?

  4. Bruce Bartlett. Keynes Was Really A Conservative. Forbes. August 14, 2009. In what sense was J.M. Keynes a conservative?

E.3 Procyclical Government spending

Consider the basic goods market model of Lecture 7: consumption is linear in disposable income, disposable income is income minus taxes, investment is exogenous and equal to \(\bar{I}\), and taxes are exogenous as well. However, government spending depends on the level of output. For example, the government systematically spends more when GDP is higher (it builds new roads, hires new teachers, etc.), and conversely when GDP is lower (it then stops construction projects, fires teachers, etc.). Thus, government spending is given by the following equation, with \(g_1>0\): \[G = g_0 + g_1Y\]

  1. Solve for equilibrium output.

  2. If \(g_1+c_1<1\), what is the value of the tax multiplier? (the tax multiplier is equal to the increase in output following from a $1 decrease in taxes) If \(g_1>0\), is the multiplier higher or lower than when government spending does not depend on GDP (\(g_1=0\))? What is the intuition for this?

  3. Does this kind of policy appear like a good policy?

  4. Give both a graphical as well as an algebraic justification for the value of the multiplier.

  5. What happens if \(g_1+c_1>1\)? Explain using the multiplier intuition.

E.4 Accelerator and Automatic Stabilizer

Consider the basic goods market model of Lecture 7: consumption is linear in disposable income with a Marginal Propensity to Consume equal to \(c_1\), disposable income is income minus taxes. However, we assume an accelerator effect of demand on investment (investment depends on sales): \[I=b_0 + b_1 Y,\] as well as the presence of automatic stabilizers: \[T=t_0+t_1Y.\]

  1. Solve for equilibrium output.

  2. Find a condition on \(b_1\), \(c_1\), and \(t_1\) such that the multiplier stays finite.

  3. What happens if the multiplier is infinite? Does GDP become infinite?

  4. Give both a graphical as well as an algebraic justification for the value of the multiplier.