Why Do Economists Still Disagree over Government Spending Multipliers - Annotated Bibliography Example

Micro & Macro Economics Table of Contents Article Why Do Economists Still Disagree over Government Spending Multipliers?” 3 Article 2: “FightingDownturns with Fiscal Policy”  4 Article 3: “Crises Before and After the Creation of the Fed”  5 Article 4: “Economics Instruction and the Brave New World of Monetary Policy” 6 Article 5: “The path of wage growth and unemployment” 7 Article 6: “Will inflation remain low”? 8 Article 7: The U.S content of “Made in China” 9 Article 8: “What Are the Risks to the United States of a Current Account Reversal?” 10 Article 9: “Balance of payments in the European periphery” 11 Article 10: Productivity and Potential Output before, during, and after the Great Recession 12 Works Cited 13 Name of student: Name of Professor: Course Number: Date of Paper: Micro & Macro Economics Article 1: “Why Do Economists Still Disagree over Government Spending Multipliers?” The article tries to address the debate which the economists have constantly faced while evaluating how an increase in today’s government spending have affected future output. This effect is commonly known as government spending multiplier and there have been challenges in measuring it. A model has been designed to estimate the government spending multiplier theoretically. The relationship among the components of the model can be described by the identity below: GDP Supplied = Consumption + Investment + Government Spending + Net Exports The identity is called the “aggregate resource constraint” (Caroll 1-5). Each components of this identity needs to be studied. This will give a clear picture of how government spending may affect GDP. Nevertheless, policymakers are still doubtful whether an increase in government spending will lead to rise in GDP or not as a wide range of multipliers are possible depending on how the spending is financed. Measuring the Multiplier Empirically The effect of government spending on output can be empirically measured by comparing data on real GDP and government spending. There exists a causality relationship among both the factors. Unpredictable public expectation also causes a problem in identifying the effect of government spending on GDP. These problems can be addressed by using Vector auto regression (VAR). However, limitation of data leads to less precise results. Literature suggests different modelling assumptions which lead to different conclusion about the government spending and the empirical challenges gives rise to debates over the size of multiplier (Caroll 1-5). Article 2: “Fighting Downturns with Fiscal Policy”  The article tries to answer whether fiscal policy can be used to fight recessions. The effect of change in fiscal policy on real GDP is not straight forward according to basic Keynesian theory. Many underlying assumptions are considered in this framework. Households do not assess their future income and spend as long as their income is high. However, households adjust their consumption with the prevailing tax rate. Changes in fiscal policy are not affected by investment and net exports. However as investment depends on interest rate which in turn depends on monetary policy, any change in monetary policy due to changes in fiscal policy might also change investment. This model is challenged by the new Keynesian model. The real GDP is quite sensitive to the behaviour of households, firms and monetary policy. This is due to the fiscal policy that directly affects real GDP. This gives scope for empirical work on the same. Empirical studies produce results which are in contrast to the theoretical predictions from the simple Keynesian framework. Over the 10 years, fiscal incentives have been considered by congress to address the above challenges. The following two years would experience significant growth enhancement, as suggested by empirical studies. This increase in growth would be influenced by considerable tax cuts that are flexible and easy to implement. Output will also increase substantially. Economists are continuously debating on this issue and are still uncertain about how fiscal multipliers will affect the economy due to unpredictable household behavior (“Fighting Downturns with Fiscal Policy”). Article 3: “Crises Before and After the Creation of the Fed”  The article illustrates the economic situation before and after the creation of Fed. It was created to manage the monetary policy that will in turn enable it to act as a lender during the time of crisis, and for promoting stable prices and full employment in response to the recession in 1907. After 100 years, comparison of the recession in 1907 and the Great Recession suggests that the creation of Fed has been a significant breakthrough in terms of crises mitigation. Both the crises shared considerable similarities and at the same time had different institutional responses. A public lender was not available in 1907. The creation of Fed can be justified by evaluating whether it can shorten the business depression that follows a financial crisis or not. Both the crisis, similar paths but recovery from the trough was quicker in 1907. Also unemployment rate suggests that 1907 panic would have been shallower and unemployment rate would have been less if there was a federal reserve back in time. The actual interest rate was two percentage points below the predicted for the Great Recession while the actual interest rate was one percentage point above for the 1907 episode. This reflects Fed’s rate cutting in response to financial crisis which was absent during 1907. The interest predictions would have affected GDP and it would have tapered 2% less than actual in 1907 (“Crises Before and After the Creation of the Fed”). However, the stimulus packages passed to boost GDP did not come into effect till 2010. Hence, fiscal policy cannot explain differences in recovery paths. The presence of Fed distinguishes both the financial crisis and the economic situation and it can be concluded that Fed has been successful in mitigating recession to some extent (“Crises Before and After the Creation of the Fed”). Article 4: “Economics Instruction and the Brave New World of Monetary Policy” This article addresses the challenges faced by economics education due to constant changes in monetary policy in recent decades. Various banking innovations and interest rate changes are not often properly considered in standard textbooks. It is necessary for the people to have knowledge about economics and monetary policy so that they could have their own opinion and judgements about the Federal Reserve and this would help them to understand the policies. There have been changes in technology and with it concept of money has also changed. Modes of banking have changed. Traditional textbook theories emphasise on monetary policies which are mainly influenced by classical theories and reflects manifold deposit creation. This means that bank holds reserves to the extent they have to do to satisfy regulatory mandates. However, this is not the way how the banking sector works. There has been a shift in the multiplier. This is because banks have hold reserves safely instead of lending it to Fed. Fed changes the interest rate on reserves periodically. This is not often taken into account by the textbook models of money supply & money multiplier. The textbooks also do not address the Federal Reserve’s asset purchase program properly. The fed’s policy of providing further incentive by purchasing securities of long term nature was missing from the textbooks. Also Fed’s role of acting as a lender was not given much importance in the standard textbooks. It was only considered as a monetary authority. Hence, for educating citizens about the monetary situation of an economy, there is a need for better explanation of the theoretical and practical bases of the policies of Fed (“Economics Instruction and the Brave New World of Monetary Policy”). Article 5: “The path of wage growth and unemployment” The article emphasizes on the unemployment scenario in U.S during and after the Great Recession. The trend of wage growth is also studied. It particularly tries to show the path and evolution of wage and unemployment rate. The phenomenon called “downward nominal wage rigidity” has been important during all past recession. The Great Recession gave a clear picture of it. There was wage rigidity. This led to positive growth of nominal wage. The relationship between wage and labor market slack measured by unemployment can be examined by the Philips curve and it shows how the normal inverse relationship deviates between both deviates during recession. Generally, slower wage growth is correlated with higher slack and faster wage growth is correlated with lower slack. This relationship breaks down during and after recessions. Labor market slack and wage growth moves together and shares a positive relationship that demonstrates the average wage Philips curve during the early part of recoveries. The clockwise loops in the wage Philips curve reflect the fact that even if businesses would like to reduce wages, it cannot do so due to wage rigidity. With the recovery, wage growth reduces gradually. Hence, downward normal wage rigidity has been an important force during most recessions and recoveries and has caused a divergence in the usual relationship between unemployment gap and wage growth which is corrected gradually (“The Path of Wage Growth and Unemployment”). Article 6: “Will inflation remain low”? This article examines the behavior of inflation using the well known Phillips curve model and tries to follow its implications for inflation that would persist over the following 2 years. The basic model shows how present inflation depends on lagged inflation and how it gives an estimate of economic slowdown. However, the basic model ignores various determinants of inflation and as a result various extensions to the framework have been developed that is potentially important for the examination of inflation over the years. The basic Philips curve shows persisting inflation. It describes the behaviour of current inflation as a function of the past unemployment gap and past inflation and puts emphasis on the Non-accelerating Inflation Rate of Unemployment (NAIRU) which is the unemployment rate persisting when the economy is at its full capacity. The unemployment rate will lie above NAIRU when the economy is in distress. Nevertheless, the basic Philips curve is a parsimonious model and leaves out several important determinants of inflation. Inflation remained low over the past two years. This was estimated with the help of “core personal consumption expenditures price index “(core PCEPI). It does not consider volatile energy and prices of food. To extend the basic model, a restriction is imposed on the core PCEPI inflation at steady-state and it is required to lie at 2% which is the inflation rate that is targeted by Fed (Cao 1-4 ). Also, the measure of slack is altered in the Philips curve inflation forecast. This is done to account for a dichotomy which points out that long term unemployed put less upward pressure on wages and prices than the short term unemployed. Firms often prefer employees who have recently become unemployed and hence rather than overall unemployment, short term unemployment is in focus. Strong upward pressure on prices can be reflected by excess demand projected by short term unemployment rate. Therefore, the extended Philips curve produce higher projections for future inflation which is in contrast to the basis Philips curve which suggest that inflation will continue to remain low (Cao 1-4). Article 7: The U.S content of “Made in China” The article evaluates United States consumer spending for Chinese goods and the actual cost of imports from China. It tries to identify the U.S consumer spending on goods from China and U.S itself. It also tries to understand what part of the cost of goods that are made in China is actually due to the cost of these imports and what part reflects the value added by U.S. transportation, wholesale, and retail activities. The article also tries to address U.S consumer spending that is dedicated to expenditure on goods that are imported from China. These goods are not only sold directly to consumers, but also are used in the intermediate production stages. The U.S economy remains relatively closed in spite of globalization and 88.5% of U.S. consumer expenditure is on items made in the United States while Chinese goods account for 2.7% of U.S. PCE, about one-quarter of the 11.5% foreign share (Hale and Hobijn 1-4). Also, there is higher retail and wholesale margins some goods like electronics. The goods imported into the U.S are not always directly sold to households. It is also used in the production of goods and services in the U.S. There is a difference between the total share of PCE that goes for goods and services imported from China and the share of Chinese produced final goods and services in PCE due to the utilization of goods imported from China as an intermediate in the U.S. production of services. Industries with higher Chinese imports would experience higher inflationary effects. Also, recent increase in labor cost and rising prices in China may not generate inflationary pressures in the United States since the share of PCE that attributes to imports from China is less than 2% and some of this can be traced to production in other countries (Hale and Hobijn 1-4) Article 8: “What Are the Risks to the United States of a Current Account Reversal?” The article examines the risks associated with a current account reversal in the U.S. The policymakers and analysts are in concern over the growing deficit and this deficit implies a perceived risk that it could reverse. Some economic models predict that a current account reversal may have a negative impact on economic output, asset prices and the exchange rate. Past adjustments in developing countries shows that investment and consumption growth characteristically lead to quick widening of the current account deficit. While consumption and investment contract and output quickly slumps as foreign financing dries up during sudden stops. However, all reversals are not associated with output contraction. Past adjustments in industrialized countries show that adjustment of current account was related to humble decrease in economic activity and GDP growth. Some contraction episodes show that growth of output has turned somewhat negative about a year after the current account reversal while the expansion episodes experienced depreciations of currency that occurred without an asset price collapse. The effects of current account reversal in U.S. are important to study as they had a global impact. The slowdown of the U.S. economy would affect its trading partners and make the adjustment of current account difficult to achieve. The dollar depreciation along with a current account reversal will have worldwide financial implications. It would result in capital loss for foreign banks that holds a large amount of their reserves in dollar. Developing countries would experience a drop in U.S demand for their goods and a fall in their reserves and this would make them more vulnerable to currency crisis. Historical evidence supports that there are less chances of a quick adjustment of current account. However, the large size of the U.S. economy makes the risks more substantial as the slowdown in the US may affect the global economy leading to financial disruption (Valderram 1-3). Article 9: “Balance of payments in the European periphery” The article illustrates the crisis of balance of payments that persists in the European due to current account deficit and low inflow of private capital. This is known as a sudden stop periphery. Financial turmoil in emerging markets was essentially characterized by situations where countries were unable to finance their foreign transactions which were followed by a situation where country’s imports exceeded its exports, a condition known as current account deficit. A persistent current account deficit is accompanied by lending booms in which the government, the financial sector, or both borrow too much from foreign creditors. This aggravates the situation. Current account will shift from deficit to surplus in countries with fixed exchange rates as sudden stops will particularly lead to drain of foreign reserves and it will force depreciation of currency. When the government is no longer able to defend the fixed exchange rate, a balance of payment crisis turns into a currency crisis. Several Countries like are experiencing balance of payments crises which has stemmed from constant current account deficits and outflow of net private capital which are similar to sudden stops in capital flows in emerging markets. Currency collapses were triggered which restored external accounts to sustainable paths. However, European periphery countries have not moved towards devaluation by abandoning the euro due to the sudden stop as capital transfers from euro-area partners have allowed them to finance current account deficits (“Balance of Payments in the European Periphery”). Article 10: Productivity and Potential Output before, during, and after the Great Recession This article looks at how potential output has evolved and also studies the trend of labor productivity and related variables that are associated with growth, during, and since the Great Recession. Output and productivity growth has not followed a similar path during the different phases of business cycles. The great recession provides a contrasting picture of how output behaved before, during and after the recession. After the early 2000s, Labour growth slowed. This continued till mid 2000s. Total productivity also fell during this time, after acceleration in the mid 1990s. The growth in total productivity earlier during late 1990s was mainly due to the effect of information and communication technology (ICT). However, gains from ICT started falling in the mid 2000s and this affected total productivity. During the Great Recession and in the early recovery phase, productivity performance was similar to previous recessions. Although, some literature perceived productivity to be quite strong at the time of recession and recovery Firms were sceptical about the recession and started speculating before the crisis. They tried to mitigate the effects of deep recession by cutting workers. Firms laid more emphasis on the intensity i.e. no. of hours per worker margin while deciding about their strategies. The recession that was experienced after a war saw a fall in intensity margin and growth of capital stopped entirely. Hoarding of capital and labour were significantly noticed. The recovery phase was characterized by measures of factor utilization that quickly rebounded and there was a return of total factor productivity and labour productivity to their anaemic mid-2000s trends. There was a slower pace of underlying technology. Output grew even more slowly during the recession and recovery which reflected the effect of weak investment on growth in capital input (Fernald 1-27). Works Cited “Balance of Payments in the European Periphery.” Economic Research. Federal Reserve Bank of San Francisco, 2014. Web. 27 August 2014. Cao, Yifan and Adam, Shapiro. “Why Will Inflation Remain Low?” Economic Letter 19 (2014): 1-4. Web. 27 August 2014. Caroll, Daniel. “Why Do Economists Still Disagree over Government Spending Multipliers?” Economic Commentary 9 (2014): 1-5. Web. 27 August 2014. “Crises Before and After the Creation of the Fed.” Economic Research. Federal Reserve Bank of San Francisco, 2014. Web. 27 August 2014. “Economics Instruction and the Brave New World of Monetary Policy.” Economic Research. Federal Reserve Bank of San Francisco, 2014. Web. 27 August 2014. Fernald, John. “Productivity and Potential Output before, during, and after the Great Recession.” Federal Reserve Bank of San Francisco 18 (2012): 1-27. Web. 27 August 2014. “Fighting Downturns with Fiscal Policy.” Economic Research. Federal Reserve Bank of San Francisco, 2014. Web. 27 August 2014. Hale, Galina and Bart, Hobijn. “The U.S. Content of “Made in China”.” Economic Letter 25 (2011): 1-4. Web. 27 August 2014. “The Path of Wage Growth and Unemployment.” Economic Research. Federal Reserve Bank of San Francisco, 2014. Web. 27 August 2014. Valderram, Diego. “What Are the Risks to the United States of a Current Account Reversal?” Economic Letter 29 (2006): 1-3. Web. 27 August 2014. Read More