Section 1 – Two Nations, Soara and Feara, both witness a sharp rise in the MPS. (30 points)

In Soara , the rise in MPS reflects consumers’ reaction to a material rise in risky company            business expansion opportunities . Many companies expanded their production capacities, driven by exciting technological innovation —there were discoveries that led to techniques to use high   powered computers to radically transform electricity usage, thereby making solar panels sensible investments for most houses in the USA .

In Feara, the in the MPS reflects consumers’ reaction to a deadly virus . Panic social distancing lead many to lose their jobs . The vast majority of the population decided to save more of their income, as insurance against the risk that they, too, might lose their jobs in the near future .

To restate, for emphasis, in both nations the MPS rose . Some economists argue that if the MPS rises, the reduction in consumption that results do not necessarily slow the economy, because    higher saving leads to higher investment . Others espouse a more nuanced view . Do you expect  investment to rise in both Soara and Feara? Use the loanable funds model to make your case.

1.   In the space above, draw an equilibrium position for Soara before the change in the MPS. (5 points)

2.   Now shift the curve or curves that are consistent with a rise for the MPS . (5 points)

3.   How do the shifts you presented confirm or refute the notion that a rise in MPS result in a rise for investment?  (5 points)

4.   In the space above, draw an equilibrium position for Feara before the change in the MPS. (5 points)

5.   Now shift the curve, or curves, that are consistent with a rise for the MPS . (5 points)

6.   How do the shifts you presented confirm or refute the notion that a rise in MPS result in a rise for investment? (5 points)

Section 2 – Loanable Funds Model (35 points)

The charts below depict lending and borrowing for the U .S . economy in late 2030:

1.   The two quadrants above depict the U .S . loanable funds markets in late 2030. Label the curves and identify, on the graph,  the equilibrium real corporate borrowing rate and the equilibrium quantity of lending to U .S . corporations . Likewise, identify the equilibrium quantity of borrowing by the U .S . government, and the equilibrium interest rate that      households receive .

What is the spread between the two equilibrium borrowing rates? (5 points)

The Federal government, in late 2030, enacts a very large green energy spending program . The U .S . government, in 2031, needs to borrow 100% more than they did in 2030. In 2030 inflation, inflation is expected to rise by 1 .5% per year . In 2031, inflation rises and inflation expectations rise to 2 .5% .

2.   In the government quadrant, adjust the picture to represent the change in government policy . Identify the new equilibrium interest rate, and the new equilibrium level of    lending to the government . (5 points)

3.   We now have a new equilibrium rg   . How will that affect the loanable funds market for corporations? (5 points)

4.   Given rg  , draw in the change you expect to see, in the corporate loanable funds market . (5 points)

5.   If nothing else changes, will corporations be investing and borrowing more or less? What do economists label this change in private investment, in reaction to a change in               government borrowing? (5 points)

6.   Suppose, however, that the government spending on green energy also generates great      enthusism in the business world, as it lifts demand for many products . Suppose  these       enthusiastic business leaders recalculate their investment opportunities, nw that they see   stornger growth for their products . Draw the necessary additional curve shift, so that your chart depicts both effects . (5 points)

7.   Suppose you looked on a Bloomberg screen in 2030, and again in 2031. What would the interest rate be that the government paid, to borrow money from households in 2030?     What would the interest rate be in 2031? (5 points)

Section 3 – The Phillips Curve (35 points)

1.   Write down an equation for the Phillips Curve . (5 points)

2.   Explain in words the relationship between expected future inflation and current inflation and the relationship between the unemployment gap and current inflation that the Phillips Curve implies . (5 points)

3.   Suppose that in late 2029 you estimate the slope of the Phillips curve (a) coefficient by using the historical inflation and unemployment data from 2024 through 2029. Your analysis of the data leads you to believe that a = 0.5 . Suppose you also judged that

U*  = 4% and that   e  = 2%.

Over the 2024-2029 period swings for U and π have been modest and the Phillips curve has been a successful tool for predicting inflation .

In 2030, however, unemployment soars, equaling 16% for the year . You exercise your Phillips curve model . What does it predict for inflation in 2030? (5 points)

4.   In 2030, the actual inflation rate turns out to be 0 .8% . What would be the parameter value for a that correctly predicted 2030 inflation, using a standard Phillips curve? (5 points)