Macroeconomic

policy_paper_1_spring_2013.doc

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Policy Paper 1

Economists study the relationships between variables. For example, economists might study the relationship between education and income, between investment and exchange rates, or between prices and quantities sold. Macroeconomists are concerned with the relationships between macroeconomic indicators like unemployment, inflation, growth, and the supply or money. Because of their knowledge of these relationships, economists are often asked to provide policy recommendations. For example, should the Federal government raise taxes? If so, on whom?

This assignment provides you with an opportunity to provide your own policy prescriptions. There are two major objectives of this assignment. First, you will demonstrate knowledge of the relationship between inflation and unemployment through use of the Phillips curve. Second, you will provide policy recommendations, in light of this relationship, on how to achieve low long-term unemployment in the US. This is a long-run paper. Therefore, I am looking for evidence that you understand the relationship between government policies and long-run unemployment. If you find yourself thinking about a short-run benefit, you may be off track. In this case, I recommend talking with me.

Part 1: Economic Concepts. This section covers the relationship between unemployment and inflation through use of the short-run and long-run Phillips curves. You may type or write your answers to questions in this section. However, please note that it must be stapled to your essay in part 2.

a. Copy and paste the following link into your browser:

http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20121212.pdf

What are the Federal Open Market Committee’s “Longer-run” projections for unemployment? Please choose the “central tendency” numbers.

b. How can you argue that long-run unemployment projections are the same thing as the natural rate of unemployment/NAIRU? I’m looking for a 3-4 sentence answer here.

c. According to the Federal Reserve, when is the earliest possible year we could reach the natural rate of unemployment/NAIRU?

d. According to the Wall Street Journal article (that you read before the first midterm), what are three reasons for the increase in the natural rate of unemployment? You may note that the previous estimate was around 5%.

e. Read the NY Times NAIRU article posted on blackboard and answer the following two questions

i. According to the New York Times article, why are lots of manufacturers unable to find adequate workers?

ii. According to the New York Times article, what are examples of skills that manufacturers now require more than they used to?

f. Draw a short-run Phillips Curve where a 2% rate of inflation is associated with the NAIRU (you may choose any within the range given in the Federal Open Market Committee’s projections).

g. Draw the long-run Phillips Curve associated with the new NAIRU. Label this LRPC.

h. Suppose the Federal Reserve does not realize the NAIRU has increased and continues to use expansionary policy after the economy has completely recovered (the unemployment rate is equal to the new NAIRU). What will happen to inflation (in the short-run)? Draw the new point on your graph and label it point A

i. What will the new rate of inflation do to expected inflation? Make sure you explicitly answer this. What will this do to the graph? Draw this change on your graph, labeling the change “I”

j. What will the unemployment rate eventually return to? Draw a point on your graph to represent this. Label this point B.

k. Using your graph, show what will happen to the economy as long as the Federal Reserve continues to use expansionary policy to try to obtain a 5% rate of unemployment. You may go through two or so cycles in order to do so.

Part 2: Policy Proposal

For this section, you will write an essay answering the following question: “What three policies should the US government pass to promote PERMENANTELY low unemployment?” The essay will contain the following information

There are two main parts to the essay.

a. First, you must draw insights through your work on the economic concepts above to describe why expansionary policy will not reduce US unemployment in the long-run. You must refer to the phillips curve (and specifically the answers to your questions above) in order to do so.

b. Given the context described above, you will write your policy proposal. In this part of the paper, you will propose and justify three policies that WILL promote low long-run unemployment in the US. You must be specific about what each policy entails. For example, you can’t simply say that the US government should invest in green technology. If you choose this sort of a policy, you will need to specify exactly what technology the US should invest in and why. You must also explicitly justify why the policy will promote low long-term unemployment. For example, you may argue that a policy will reduce frictional unemployment by better matching workers with jobs.

The paper will be at least five paragraphs long

Paragraph 1 will contain part a

Paragraphs 2-4 will describe your three policies

Paragraph 5 will conclude

There is no page requirement for the essay. However, I would be concerned if it’s less than two pages (double-spaced) or more than 5.

Grading Criteria/Expectations

1. You do not need any sources for the paper. I am grading this on your knowledge of course materials, so you may certainly earn an A without using external sources.

2. However, you may use sources if you don’t know much about a topic. If you use a source, you MUST cite it using an MLA or APA format. If I suspect you are plagiarizing, I will submit an honor code violation.

3. If you’re excited about a policy and believe you may make TWO arguments, you may choose to substitute one of your three policies for an argument. That is, you may have two policies instead of three, but one of the policies should have two separate arguments.

4. You must justify that your policy will cause LONG-TERM changes in the labor market. Justify this as clearly as possible. If you are unsure about the difference between long-term changes and expansionary policy, ask me!

5. Your policy must be realistic. In other words, you can’t say that we should invade Mexico. If you’re not sure whether your policy is realistic (or are very excited about an unconventional policy), ask me.

6. Your policy might have unexpected benefits. For example, you might argue that there are also moral or political reasons to enact your policy. These benefits will be helpful to include, but are not a substitute for explaining why the policy will permanently change the natural rate of unemployment.

7. Your policy might also help stimulate the economy. For example, government spending on something might also help get the US out of our current recessionary gap. Keep in mind that stimulating the economy is very different from changing the natural rate of unemployment. Any argument that a policy will stimulate the economy will not count for credit. You might choose to mention these things (to strengthen your case), but you absolutely do not have to.

8. If English is your second language, you may need to put in extra work. I recommend signing up for an appointment with me (see the instructions below). However, because I have limited time available, I will focus more on your arguments than your writing during our appointment. If you are concerned about your writing, I strongly recommend seeing the writing center. This means that you must start your essay early.

Grading Rubric

1. Did the student correctly draw on the short-run and long-run Phillips curves to set up the appropriate context for his/her proposals?