Problem set #4 Suggested Solutions



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Department of Economics Fall 2014

U.C. Berkeley Economics 1

Problem Set #4 Suggested Solutions Page


PROBLEM SET #4 Suggested Solutions

NOTE: If your total of the PS1+PS2+PS3 scores + iclicker points put you pretty close to the maximum of 40 points, your GSI looked over your PS4 quickly and gave it a  (check or check-plus) rather than a specific score and set your total of problem set+iclicker to the max of 40. In that case, you want to read through the solutions carefully and compare your answers with what’s here because you won’t see any of those lovely “Please see solutions” stamps on your returned PS.

If your total of the first three problem set scores + iclicker points put you more than 5 points away from the max of 40 points, your GSI graded your PS 4 as per usual and you have a point score at the top of your returned problem set.

1. (2 points total)


a. What is the Federal Funds rate?
The Federal Funds rate is the interest rate banks charge each other for overnight loans of reserves. U.S. banks are required to maintain reserves equal to 10 percent of their total deposits. (See http://www.federalreserve.gov/monetarypolicy/reservereq.htm) Banks that are unable to meet their reserve requirement are able, however, to borrow from banks with excess reserves (they can also borrow from the Fed at a higher rate.)
The Federal Funds rate is determined in the market by changes in the supply of and demand for federal funds. The difference between a bank’s total reserves and its required reserves are the bank’s “excess reserves.” Banks that have excess reserves make up the supply of federal funds. Banks whose total reserves are less than required make up the demand for federal funds. Like any market, the market for federal funds will clear at an equilibrium price where the supply of federal funds meets the demand for federal funds. This equilibrium price is called the “Federal Funds rate.”
The Fed is able to manipulate this market by increasing or decreasing the amount of reserves in the banking system. Increasing the amount of reserves means than fewer banks will need to borrow in order to meet their reserve requirement, which will decrease the demand for federal funds. More reserves in the system also means that more banks will have excess reserves to lend, increasing the supply of federal funds. The net effect is that the federal funds rate will fall.
Alternatively, if the Fed decreases the amount of reserves, more banks will need to borrow in order to meet their reserve requirements, increasing the demand for federal funds. At the same time, fewer banks will have excess reserves to lend, decreasing the supply of federal funds. The increase in demand & decrease in supply have the same effect: both serve to increase the price of federal funds, that is, the federal funds rate.
b. When the Fed decreases the target for the federal funds rate, what actions does the Fed take to try to achieve that new FFR?
When the Federal Reserve decreases the target for the federal funds rate, they do this by buying assets. This action is called Federal Open Market Operations. Typically the Fed purchased Treasury bills from the public (anyone who wanted to sell a T-bill, which might well have included banks). In recent years, the Fed has bought all manner of assets from banks, as is shown in the Fed’s balance sheet: http://www.clevelandfed.org/research/data/credit_easing/index.cfm . When the Fed buys assets from the non-bank public, it pays by giving money (a checking deposit) to the sellers of the bonds. This money is deposited into a bank. The bank receives the funds when the Fed increases the bank’s balance in its reserve account. When the Fed buys assets from banks, it pays by directly increasing the balance in the bank’s reserve account. Because there are now more reserves in the banking system as a whole, the interest rate banks can charge each other as they lend reserves to each other – the federal funds rate – falls.
c. What is the new interest rate policy tool that the Fed has signaled it will start using when they begin raising rates?
Starting in October 2008, the Fed has been paying interest to the banks on the balances in their reserve accounts. (For more details, see http://www.federalreserve.gov/monetarypolicy/reqresbalances.htm .) The Fed is currently paying 0.25% on both required and excess reserves. It can however pay a different rate on excess reserves than it does on required reserves. At its September 2014 meeting, the FOMC announced that as it moves to increase interest rates to their neutral rate (“monetary policy normalization”), the Fed will change the interest rate paid on excess reserve balances as its strategy for achieving the Federal Funds rate target. See http://www.federalreserve.gov/monetarypolicy/policy-normalization.htm . federal funds rate 2007-2012.jpg
d. What is one advantage to the new policy tool mentioned in (c) over the traditional tool of targeting the FFR?
A big advantage to using the interest rate paid on excess reserves as a strategy for achieving the federal funds target – rather than relying on Federal Open Market Operations – is that the Fed can completely control the interest rate paid on excess reserves. It is not determined in the market; it is set by the Fed. The Fed learned during the Crisis that its ability to achieve its target FFR through open market operations worked well in normal economic times but failed miserably in a crisis. It is precisely during a crisis that we want the central bank to be able to conduct policy with some degree of accuracy!

2. (1 point)

Carefully and fully, explain why a decrease in interest rates in the U.S. should lead to a rise in employment in the U.S. Format your answer in a way that makes it easy for your GSI to grade. (Maybe ask your GSI what makes grading easier.)
Four steps:


  1. a decrease in interest rates increases investment spending (I)

  2. a decrease in interest rates increases net exports (NX = EX – IM)

  3. multiplier effects create a much larger total change in GDP

  4. an increase in GDP corresponds to an increase in employment


Details:


  1. a decrease in interest rates increases investment spending (I)

interest rates → some projects that had been unprofitable at prior interest rates (because their expected rates of return were lower than then-prevailing interest rates) are now profitable, & will be undertaken → ↑ money spent on equipment and construction → ↑ investment


2. a decrease in interest rates increases net exports (NX = EX – IM)
interest rates

→ wealth holders around the world will re-allocate wealth away from U.S. financial assets and toward the financial assets of other countries

→ ↑ demand for foreign currency and ↓ supply of foreign currency

→ ↑ price of foreign currency (exchange rate)

dollar has fallen/is weaker (more dollars per unit of foreign currency) and other currencies have risen/are stronger (fewer units of foreign currency per dollar)



→ ↑ price of foreign goods and services to U.S. buyers and ↓ price of U.S. goods and services to foreigners

→ ↓ U.S. purchases of foreign goods and services (imports) and ↑ foreign purchases of U.S. goods and services (exports)

→ ↓ IM and ↑EX

NX
3. multiplier effects create a much larger total change in GDP
The initial increases in investment and net exports kick off the multiplier process.

I and ↑NX



→ ↑output of investment goods and exported goods and services

→ ↑ income for the people involved in producing those goods and services

→ ↑ spending by those people who received the additional income

→ ↑ output of consumer goods and services

→ ↑ income for the people involved in producing those consumer goods and services

many additional rounds of ↑spending, ↑output, and ↑income

the total change in Y is the sum of the changes in Y in each of the many rounds of the multiplier process and is much greater than the ↑I and ↑NX that started the process.
4. an increase in GDP corresponds to an increase in employment
Each round of the multiplier process involved increased output and income. That increased income reflected either new jobs for previously unemployed workers or additional hours for existing workers. If new workers are hired, that’s an increase in employment.

3. (1 point)



a. Look back at your argument in question 2. Identify an assumption in your argument that was not satisfied in the U.S. during the early years of the recovery from the 2007-2009 recession. It should be an assumption that, because it was not satisfied, the decrease in interest rates in the U.S. did not lead to a rise in employment in the U.S. Write down the assumption here.
You only needed to choose one. There are many to choose from. I may have even forgotten some!


  • Investment spending increases only if

    • Lenders lend – if there is a credit or financial crisis that corresponds to profitable ventures going unfunded, then lower interest rates won’t increase investment spending

    • Expected rates of return don’t change too – if the same factors that led to a drop in interest rates (e.g., the central bank is responding to a collapse of the economy) also lead business people to lower their forecasts of future sales, then lower interest rates won’t increase investment spending

    • Long-term interest rates change when short-term rates change. If financial assets are operating as per usual, with imperfect substitution between different asset categories, then a change in short-term rates will affect long-term rates as well. But if banks and other wealth-holders are not willing to substitute long-term debt for short-term debt, then the change in short-term interest rates won’t affect long-term rates. If long-term rates don’t change, investment is unlikely to change.

  • Net exports increase only if

    • The drop in interest rates in the U.S. isn’t matched by a drop in interest rates in the rest of the world – relative interest rates matter. If all interest rates fall, then there will be no re-allocation of wealth across countries. Without the re-allocation of wealth, there’s no change in exchange rates and therefore no change in net exports.

    • Trading of financial assets across international boundaries is allowed – some countries have “capital controls” in place, preventing either purchases of foreign financial assets by their residents, or purchases of their country’s financial assets by foreigners. If there’s no trading of financial assets across borders, there’s no change in exchange rates and therefore no change in net exports.

    • Exchange rates float – we didn’t have time in class to cover fixed versus floating exchange rates. Some countries (fewer and fewer) intervene in the market for their currency so that the exchange rate isn’t simply determined by the market’s supply & demand for the currency. If a country prevents its exchange rate from changing, there’s no change in net exports.

  • Multiplier effects make the total change in Y even larger only if

    • The mpc > 0 and the mpc > mpm – if there is no change in demand for domestically produced goods and services, then there will be no multiplier effect.

    • Other components of aggregate demand aren’t decreasing – if the increase in I & NX is offset by decreases in C & G, then there will be two sets of multiplier effects. One multiplier process will amplify the effect of the increased I & NX. The other multiplier process will amplify the effect of the decreased C&G. The net effect could be no change in Y.

  • More output means more employment only if

    • Labor productivity doesn’t increase a lot – if productivity rises a lot, output can increase without any increase in employment

b. How does the assumption you identified in part (a) help explain why the recovery from the 2007-2009 recession in the United States was so slow?


Several of these implicit assumptions are relevant to understanding the 2007-2009 recession. Lenders didn’t lend despite the existence of profitable projects; instead they let their excess reserves soar. Businesses lowered expected rates of return as interest rates fell; both events were triggered by the economic effects of the financial crisis. Short-term rates fell but long-term rates didn’t fall by anything close to the same degree. Short-term interest rates were slashed not just in the U.S. but in Europe as well. At the beginning of the crisis, C fell: a shift down of the consumption function due to wealth effects (drop in housing wealth & stock market wealth) and credit effects (loss of loans based on home equity).

4. (2 points total)

a. At the right, draw a Phillips Curve. Label everything.
The Phillips Curve shows the tradeoffs between the inflation rate and the unemployment rate, holding constant (1) inflationary expectations, (2) supply shocks that affect the cost of inputs, and (3) labor productivity growth. You could draw either type of Phillips Curve – PC1 or PC2. The difference between the two is that for PC2 there are some rates of unemployment for which the economy would experience negative rates of inflation: deflation.

b. Why does the Phillips Curve slope down?


The idea behind the downward sloping Phillips curve has to do with worker’s bargaining power. If the unemployment rate is low, employees have more bargaining power and can demand higher wages or threaten to leave for another employer. Firms will need to pay a higher wage to attract new employees (or to make sure their existing employees don’t leave). Firms will charge higher prices to make up for the higher wages they now need to pay workers. This leads to a higher inflation rate. Thus a higher inflation rate correlates with a low level of unemployment.
You can think about this either from the perspective of existing workers for particular firms, or from the perspective of new workers hired by a firm. Existing workers have more bargaining power if unemployment is low because they have lots of alternative employment opportunities. To keep these workers, the firms will have to agree to pay higher wages to prevent the workers from going to another firm that pays them more. If firms pay higher wages, they will have to increase prices to pay for their higher costs.
From the perspective of hiring workers, we get the same result. The lower the unemployment rate, the tighter are labor markets. Employers wanting to hire additional workers will often need to entice workers away from their existing jobs. To do this, firms bid up wages, pushing up the costs of production, which ultimately push up the prices of output. The inflation rate will be high.



Conversely, the higher the unemployment rate is, the lower the inflation rate. A higher unemployment rate means that there are a lot of workers looking for work. Existing workers do not have much bargaining power because employers can replace them with someone searching for a job. So workers must be content with relatively low wage increases or, in very bad times, wage cuts. Employers wanting to hire additional workers will be able to do so without raising wages much, if at all. So costs of production won’t rise by much, and thus output prices won’t rise by much. The inflation rate will be low. If wage cuts are prevalent, it is possible to experience deflation (negative inflation).
c. Show the effect of an increase in inflationary expectations on the Phillips Curve. Explain below.
Inflationary expectations are the answer to the question, “What do you think the inflation rate will be in the near future?”
An increase in the expected inflation rate shifts the Phillips curve up. If inflation is expected to be high in the future, workers will demand and bosses will be willing to offer higher wages than would be the case if inflation is expected to be low. For example, if the expected inflation rate rises from 2% to 8%, workers will want higher wage increases to allow themselves to keep up with inflation.
Bosses will (perhaps begrudgingly) offer higher wage increases, reasoning that in a high inflation environment, they will be better able to pass those higher wage increases on to their customers in the form of higher prices. (A key assumption here is that workers and bosses share the same inflationary expectations).
Wage inflation is thus affected by expectations of future price inflation. Wages are a measure of labor costs in the production process. Prices rise as firms raise wages. That is, price expectations that affect wage contracts eventually affect prices themselves.
A higher expected inflation rate will result in an increase in the inflation rate even though the unemployment rate may not have changed. At every unemployment rate, there is a higher inflation rate. The Phillips Curve shifts up.

d. There are three things that can shift the Phillips Curve – changes in productivity growth rates, changes in inflationary expectations, and changes in commodity prices resulting from changes in supply or changes in foreign demand. Which, if any, of these three things can be affected by the Fed? Explain.


The Fed has no control over productivity growth rates, except to the extent they depend upon the smooth functioning of financial institutions. Increases and decreases in productivity growth rates aren’t something economists can explain well, but generally they point to things such as research & development (R&D), improvements in IT, increased use of IT, and perhaps focusing after 1974 on the development of energy-efficient rather than labor-efficient machinery. None of that is in the Fed’s purview.
The Fed can influence – and tries to influence – our inflationary expectations. The Fed currently believes that it can “anchor” our expectations by having transparent policy. If we know the Fed is doing what it can to achieve no more than a 2% inflation rate, they reason, we will therefore expect a 2% inflation rate.
The Fed has no control over commodity price changes that are due to changes in supply or changes in foreign demand. The Fed benefits from favorable changes (lower oil prices make it easier for the Fed to keep the inflation rate in its desired range, even as employment rises). But the Fed can’t control OPEC, can’t control the amount of fracking in Oklahoma, can’t control Indian or Chinese demand for inputs to support growing economies.
5. (2 points total) One estimate of the Taylor rule is
Target fed funds rate = 2.07 + 1.28 x inflation – 1.95 x excess unemployment
“Excess unemployment” is unemployment above the Congressional Budget Office’s estimate of the unemployment rate at full employment. The CBO currently estimates the full-employment unemployment rate is 5%.
(Source: http://www.frbsf.org/economic-research/publications/economic-letter/2009/may/fed-monetary-policy-crisis/ ) See also http://www.frbsf.org/economic-research/publications/economic-letter/2010/june/fed-exit-strategy-monetary-policy/
a. According to this estimate of the Taylor rule, what is the target rate for the federal funds rate in each of the following situations (show work below each line; use 2 not 0.02 for 2%):
inflation rate = 2%, unemployment rate = 5%: target federal funds rate = 4.63%
2.07 + 1.282 - 1.95 (5-5) = 4.63%
inflation rate = 5%, unemployment rate = 5%: target federal funds rate = 8.47%
2.07 + 1.285 - 1.95 (5-5) = 8.47%
inflation rate = 1%, unemployment rate =10%: target federal funds rate = - 6.40%
2.07 + 1.281 - 1.95 (10-5) = -6.40%
inflation rate = 2%, unemployment rate = 9%: target federal funds rate = - 3.17%
2.07 + 1.282 - 1.95 (9-5) = -3.17%
b. What does it mean for the Fed to be at the “zero lower bound”?
When the unemployment rate is very high, the value of target fed funds rate calculated from the Taylor rule is negative. However, a negative federal funds rate implies that banks which lend to other banks not only receive no interest but they receive back less money than they lent. That won’t happen. Hence the Fed has no way to achieve a negative target fed funds rate. The lowest the federal funds rate can go is 0. So when the target federal funds rate calculated from the Taylor role is negative, the Fed can just set the target funds rate to zero. This situation refers to the Fed being at the “zero lower bound.”
c. If the Taylor Rule equation above describes how the Fed sets the federal funds target rate, why do pundits say that the Fed should have already started increasing interest rates? (You need to locate current values of inflation, unemployment, and the federal funds rate target in order to answer this question. Try Fred, the data source you used in a section exercise in October.)
Based on the Taylor rule, when unemployment rate is high and inflation rate is low, the target federal funds rate should be low; when inflation is very high and the unemployment rate is relatively low, the Fed will raise the target federal funds rate.
Currently, the unemployment rate is 5.8% and the inflation rate is 1.7%. The Taylor rule uses the core inflation rate (see the paragraph next to Figure 1 in the FRBSF newsletter, URL above). The core inflation rate (http://www.bls.gov/news.release/cpi.toc.htm, Table 1, “all items less food & energy”) is 1.8%. Plugging these values into the Taylor rule equation suggests the target federal funds rate should be 2.07 + 1.28*1.8 – 1.95*(5.8-5) = 2.8%.
The federal funds rate target is currently “in the range of 0 – 0.25%” (http://www.federalreserve.gov/monetarypolicy/openmarket.htm) which is well below the rate the Taylor rule predicts (2.8%). That is why many pundits think the Fed should have already started raising interest rates.
d. Suppose there is a drop in aggregate demand followed by a spike in commodity prices that triggers an increase in inflationary expectations. Why does the mix of hawks and doves on the FOMC matter if you are predicting the Fed’s policy reaction?
A drop in aggregate demand will raise unemployment, an event that suggests the Fed would lower interest rates. An increase in inflationary expectations will raise inflation, an event that suggests the Fed would raise interest rates. If both events happen at the same time, the Fed has to decide what to do: lower rates (because unemployment is up), raise rates (because inflation is up), or leave rates unchanged.
How the Fed makes its choice depends on the makeup of FOMC membership. Inflation hawks are more concerned with rising inflation than doves, whereas the doves are concerned less with inflation than with robust economic growth. Doves tend to see inflation as more palatable than high unemployment and weak growth, whereas hawks will more readily sacrifice economic growth to bring inflation under control. Consequently, a hawk-dominated FOMC is likely to target a substantially higher interest rate to battle inflation, but a dove-majority on the committee is likely to raise interest rates by a smaller amount. Yellen, the Fed chairman, is generally seen as dovish; her research before she first served at the Fed was in labor markets and unemployment. The FOMC currently consists of more doves than hawks. The membership changes every year, however, due to retirement, new political nominations, and annual rotation of regional bank presidents, and some of the Federal Reserve Bank presidents are openly hawkish.
6. (2 points)
Go to the website for the Federal Reserve, then to the FOMC - meeting calendars & statements page at http://www.federalreserve.gov/monetarypolicy/fomccalendars.htm. Then look at the statement the FOMC issued after its October 28-29, 2014 meeting.
Write a paper in which you do the following:

  • Choose two different sentences in the statement that you understand today that you probably wouldn’t have understood in August. For each, first quote the sentence, then explain what the sentence means using the concepts and language we have learned this semester. One paragraph for each sentence and explanation. It’ll probably look nice if you offset the quoted sentence with italics or a bullet or something like that.




  • Choose one different sentence in the statement that you still don’t understand today. Quote the sentence, then identify which (part of) the sentence you don’t understand. If you can make a guess at the sentence’s meaning, share your guess. Do you think that studying more economics would help you understand that sentence?




  • In recent years, the Fed has sought to explain clearly what they are doing and why. Discuss to what extent you think a little bit of economics education (say, a 1-semester course in micro & macro) is necessary for someone to be able to understand the Fed’s statements.




  • Do you think everyone should be required, either in high school or college, to take a semester of economics? Why or why not?

Your essay must be your own work. To present anyone else’s work as your own is theft of intellectual property: plagiarism. That means you must use quote marks “ ” around any words you quote exactly from any source (and then provide the source for the quote). It also means that if you get ideas from anyone else, or if you paraphrase someone else, you must again give them credit for their ideas. To do otherwise is plagiarism, a violation of the Code of Student Conduct and one of the worst offenses in academe. If you have questions about whether or not you’ve properly cited your sources, please talk with your GSI, the Head GSI, or Prof. Olney.


“Your own work” also means that essays crafted jointly on piazza or otherwise are not acceptable. That too is plagiarism. You can clarify and discuss the prompt with each other on piazza, but stop short of sharing specifics from your essay.
Specifications: 500 words maximum, two page maximum. (“Works Cited” list can be on a second page and does not count against the 400 word maximum.) Double space. 10-11-12 pt font. 1" margins on all sides. Your name, date, and the word count in the top right corner. Attach your paper directly behind the problem set sheets..
Grading: 0 - 1 - 2 points, taking into account content, following specifications, and writing quality.
Here’s the statement.
Release Date: October 29, 2014

For immediate release


Information received since the Federal Open Market Committee met in September suggests that economic activity is expanding at a moderate pace. Labor market conditions improved somewhat further, with solid job gains and a lower unemployment rate. On balance, a range of labor market indicators suggests that underutilization of labor resources is gradually diminishing. Household spending is rising moderately and business fixed investment is advancing, while the recovery in the housing sector remains slow. Inflation has continued to run below the Committee's longer-run objective. Market-based measures of inflation compensation have declined somewhat; survey-based measures of longer-term inflation expectations have remained stable.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace, with labor market indicators and inflation moving toward levels the Committee judges consistent with its dual mandate. The Committee sees the risks to the outlook for economic activity and the labor market as nearly balanced. Although inflation in the near term will likely be held down by lower energy prices and other factors, the Committee judges that the likelihood of inflation running persistently below 2 percent has diminished somewhat since early this year.

The Committee judges that there has been a substantial improvement in the outlook for the labor market since the inception of its current asset purchase program. Moreover, the Committee continues to see sufficient underlying strength in the broader economy to support ongoing progress toward maximum employment in a context of price stability. Accordingly, the Committee decided to conclude its asset purchase program this month. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. This policy, by keeping the Committee's holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.

To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that the current 0 to 1/4 percent target range for the federal funds rate remains appropriate. In determining how long to maintain this target range, the Committee will assess progress--both realized and expected--toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. The Committee anticipates, based on its current assessment, that it likely will be appropriate to maintain the 0 to 1/4 percent target range for the federal funds rate for a considerable time following the end of its asset purchase program this month, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored. However, if incoming information indicates faster progress toward the Committee's employment and inflation objectives than the Committee now expects, then increases in the target range for the federal funds rate are likely to occur sooner than currently anticipated. Conversely, if progress proves slower than expected, then increases in the target range are likely to occur later than currently anticipated.

When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.

Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Stanley Fischer; Richard W. Fisher; Loretta J. Mester; Charles I. Plosser; Jerome H. Powell; and Daniel K. Tarullo. Voting against the action was Narayana Kocherlakota, who believed that, in light of continued sluggishness in the inflation outlook and the recent slide in market-based measures of longer-term inflation expectations, the Committee should commit to keeping the current target range for the federal funds rate at least until the one-to-two-year ahead inflation outlook has returned to 2 percent and should continue the asset purchase program at its current level.



Your first task was to find 2 sentences in the statement that you could explain. For instance:

Information received since the Federal Open Market Committee met in September suggests that economic activity is expanding at a moderate pace.



Real GDP is increasing, but the rate of increase of real GDP is just “moderate” and not strong, or high, or otherwise whoo-hoo worthy.

Labor market conditions improved somewhat further, with solid job gains and a lower unemployment rate. On balance, a range of labor market indicators suggests that underutilization of labor resources is gradually diminishing.



We continue to see that more people are getting jobs, and the unemployment rate is falling. “Improved somewhat further” sounds like gradual increase, not as fast as one might hope. Looking at labor market indicators beyond just employment growth and the unemployment rate (see reader #17) also indicates that things are improving.

Household spending is rising moderately and business fixed investment is advancing, while the recovery in the housing sector remains slow.



C increased. I increased. Housing, which is part of I, increased, but at a slow rate (slower than hoped?).

Inflation has continued to run below the Committee's longer-run objective.



Inflation rate is below 2%.

Your second task was to find one sentence that you couldn’t explain. For instance, I’d have to look up the meaning of this phrase: Market-based measures of inflation compensation have declined somewhat; Given the context, I’d guess this has something to do with whether or not wages are rising with inflation. You just needed to write down one sentence that still didn’t make sense and make a stab at explaining it.

Your third task was to discuss whether or not someone needs to take Econ in order to understand the Fed’s statements. Would you have understood it all in August? Do you understand some of it now? Is that difference due to taking an Econ course? Do you think you’re typical? Or do you think the majority of Americans could understand the Fed’s statements even without having taken any econ at all?

Your final task was to take a stab at a normative question. Notice that we didn’t include a goal – that was your job. Probably a lot of you assumed the goal was “ability to understand the Fed’s statements.” In that case, your recommendation should follow what you wrote under the third bullet.

But you could have adopted some other goal. The task was to do what we always do with a normative question: state a goal, make a recommendation, and then defend that recommendation in light of the goal.




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