Question 1: Unemployment and Business Cycles
The behaviour of the unemployment rate over business cycles is an important area of research in Macroeconomics. For this question you will have to retrieve the unemployment series D767611 from the CANSIM data base. Retrieve the monthly data from 1980 to 1995 (16 years). Use the average method(averaging over twelve months) to derive unemployment rates from 1980 to 1995. Use two decimals (ex: 7.77789 becomes 7.78) for a given number.
A) What are the unemployment rates for 1981, 1987, 1991, 1994?
B) The natural rate of unemployment is not observed. Instead it needs to be estimated. Estimate the natural rate of unemployment for the 1980's by averaging over the years 1980-1989 (10 data points). Use the same procedure to estimate the natural rate for the 1990's (6 data points). Calculate cyclical unemployment for 1982, 1988, 1992 and 1995.
C) Has the natural rate risen when you compare the eighties to the nineties? . The Canadian Economy has been recovering since 1992.Does it make sense to talk about a jobless recovery since 1992 when you compare those rates.
Question 2 Labour Productivity, Real Wages and Business Cycles
A) What can you say about the cyclical behaviour of labour productivity and real wages?
B) What is the relationship between labour productivity and real wages over the business cycle?
C) If firms maximize profits what can say about the cyclical behaviour of the marginal product of labour?
Question 3
Consider a closed economy described by the following equations:
Cd = 400 + .8(Y-T) -100r (1) Id = 200 -300r (2) G = T = 400 (3) Yf = 3500 (4) Expected Inflation=.05 (5) L = .5Y - 200i (6) M=1730
A) Derive the IS curve and derive the LM curve. Graph both of those curves.
B) Find the equilibrium values of the real rate of interest, the nominal rate of interest and the price level. What is the level of saving in this economy.
C) Suppose that the government doubles its expenditures and doubles its taxes. Find the new equilibrium values for the real rate of interest, the nominal rate of interest and the price level. Will this economy be saving less or more than it was?
D) If you believe in the quantity theory of money, how would you draw the LM curve? If this theory describes what is happening in this economy find the new price level, the real rate of interest and the nominal rate of interest (use original vales for G and T).
E) Describe qualitatively the effects of an increase in the stock of human capital on the real rate of interest and the price level in such an economy.
Question 4
Canada is the United States' biggest trading partner. This question looks at the effects that different events can have on the exchange rate and canadian net exports to the United States. So for the following cases describe the effects on net exports and the exchange rate.
A) An increase in Canadian political uncertainty that contributes to an increase in canadian real rates of interest.
B) Pat Buchanan is elected president of the United States and imposes tariffs on Canadian goods and services.
C) Pat Buchanan is elected president, imposes tariffs on Canadian goods and services. Jean Chretien retaliates by imposing quotas on American goods and services.
D) The Canadian economy goes into a recession and the American economy avoids the recession.
THE RELEVANT DATA (SERIES D767611) IS ATTACHED TO THE COPY OF THE ASSIGNMENT.
Question 1
The unemployment rates from 1980-1995 are:
1980:7.49 1990:8.14 1981:7.55 1991:10.36 1982:10.99 1992:11.33 1983:11.92 1993:11.24 1984:11.30 1994:10.38 1985:10.54 1995:9.52 1986:9.58 1987:8.86 1988:7.77 1989:7.53
The Natural rate for the 80's is: ( Sum over the 80's)/10 = 9.35
The Natural rate for the 90's is: ( Sum over the 90's)/6 = 10.16
The Unemployment rate has two components: Natural and Cyclical:
U = Un + Uc EX: 1990 , U=8.14 , Un=9.35 , Uc=U-Un= -1.21
A) The unemployment rates are: 7.55 for 81, 8.86 for 87, 10.36 for 91 and 10.38 for 94.
B) The Natural rate for the 80's is: 9.35
The Natural rate for the 90's is: 10.16
C) For cyclical unemployment we have: 1.64 for 82, -1.58 for 88, 1.17 for 92 and -.64 for 95.
D) The Natural rate seems to be higher now. It means that we should expect a higher unemployment rate compared to what we had in the past. The Canadian Economy has been recovering since 1992 and yet unemployment is still very high. That is why one often mentions that this is a jobless recovery. We are growing but we have a high unemployment rate. The Jury is still out though as we will have to wait a few more years to see if this is actually a trend. Certainly those who believe that technological change has eliminated quite a few jobs will say that it will take a while before people retrain and get access to some of those new jobs. Some will say that our labour market regulations are costing us a lot.
Question 2
A) Labour productivity is procyclical. Labour productivity is measured by Q/L where Q is output and L is labour input. Real wages a acyclical in general (some find that they are slightly procyclical. Labour Productivity also leads the business cycle (It is one of the leading indicators that we can use the forecast upcoming events.)
B) Since real wages do not have a well defined pattern there is no clear relationship between real wages and Labour Productivity during the business cycle.
C) When firms maximize profits they keep hiring workers if the marginal benefit exceeds the marginal cost. They maximize profits at the point where MPL = W/P. Thus the marginal product of labour will mimick the behaviour of the real wage. Since the real wage is acyclical the marginal product of labour will also be acyclical.
Question 3
A) Deriving the IS curve:
Sd = Id so Y-Cd-G = Id So: Y-[400 + .8(Y-T)-100r]-G = 200 -300r
Substituting for G and T we Have:
Y -400 -.8Y + 320 + 100r -400 = 200 -300r
400r = 680 -.2Y
IS: r = 1.7 -.0005Y Slope: -.0005
Deriving the LM curve:
M/P = Md/P = L( Y, r+expected inflation)
1730/P = .5Y - 200(r + .05)
200r = -1730/P + .5Y -10
r = -1730/200P + .0025Y - .05 Slope: .0025
For a given P you get a curve.
Use the IS curve and the Full Employment curve to derive Y and r. r = 1.7 -.0005(3500) = -.05 . The real rate is negative. Thus the nominal rate is i = -.05 + .05 = 0 . Y=Yf=3500
Saving will be equal to investment thus : Id=Sd= 200 -300(-.05) = 215
For the Price level we can use our equilibrium condition in the asset market or the equation of the LM curve.
r = -1730/200P + .0025Y -.05
r=-.05 , Y=3500
P= 1730/1750
C) This time we have to modify our IS curve. IS will shift to the right and this will put upward pressure on the real interest rate. We can find the new equilibrium rate by looking at our equilibrium condition in the goods market.
Yf = Cd + Id + G
3500 = 400 + .8(3500-800) -100r + 200 -300r + 800
400r = 400 + 2160 + 200 + 800 - 3500
r= .15
Hence i = .15 + .05 = .20
P is found by using our equilibrium condition in the asset market:
M/P = .5(3500) -200(.20) , with M =1730 we have: P= 1730/1710. The price level has risen.
This economy will be saving less. Again Sd=Id so here we have Sd= 200 -300r = 200 - 300(.15) = 155. The budget is balanced but the increase in government expenditure crowds out investment and consumption.
D) The LM curve would be vertical since money demand does not respond to changes in interest rates. You can remove the interest effect on money demand and write money demand as:
Md/P = .5Y But this is exactly as if the nominal interest rate was 0 which is what we found in B). Thus the price level will be identical to what we found in B). Nothing as changed on the real side so r= -.05 Y= 3500 and i = 0 .
E) An increase in the stock of human capital will make inputs more productive and increase full employment output. Since Yf goes up the Full employment output line shifts to the right. The real interest rate goes down . With a lower real interest rate and a higher output level real money demand goes up and so the price level must go down to reastablish equilibrium in the asset market.
Question 4
Before we answer the following questions let us note that for some events there will be two effects on net exports. First a direct effect following a policy change and second an exchange rate effect which also effect net exports. We also assume no J curve effect.
A) An increase in uncertainty makes Canadian assets more risky. If the increase just compensates investors for taking more risk there will not be an increase in the demand for Canadian assets. So when the increase of the real rate just offsets the increase in risk, the exchange rate does not change. Thus net exports will not be affected. If the increase of the real rate more than offsets the increase in risk Canadian assets will look more attractive and the excange rate will appreciate causing a drop of net exports. If the increase does not offset the increase in risk then Canadian assets will look less attractive and there will be a depreciation causing a rise of net exports.
B)If tariffs are imposed on Canadian Americans would initially buy less of them. Because of that Americans will demand less Canadian dollars and this will put downward pressure on the exchange rate. The drop of the exchange rate would tend to boost net exports. Overall when we combine the two effects the net effect on net exports is ambiguous. With a weak exchange rate effect we can expect net exports to go down.
C) Tariffs on Canadian goods will reduce their demand in the United States. Quotas on American goods in Canada will limit American Imports. Initially the effect of commercial policy on net exports is ambiguous. Thus the effect on the exchange rate is ambiguous. We can't predict what will happen to the exchange rate and net exports. It reaaly depends on the goods affected by tariffs and the goods affected by quotas.
D) The recession causes a drop of Canadian Output and Income. Canadians will reduce their demand for American goods. They will supply less Canadian dollars and so the exchange rate will appreciate. Again we have two effects here.The direct effect (Decrease of Imports) and the exchange rate effect (Increase of the exchange rate and increase of imports). Combining those two effects yields an ambiguous result. If the exchange rate effect is weak, Net Exports will go up.