Name Date last 4 PSU ID Economics 304WD Homework Lesson 2 Real vs Nominal Economic Variables 90 points In this homework assignment we are getting our hands dirty to get familiar with some of the major macroeconomic variables that we will be using and working with throughout the semester Our first chapter with something to sink our teeth into will be chapter 3 and it is all about the factors of production the labor market and the production function Major variables in this part of the macroeconomy i e the supply side of the economy include but certainly are not limited to employment denoted N real wages denoted w W P where W nominal wage and P is the price index typically the CPI and real GDP denoted Y When we move to chapter 4 we encounter many more major macroeconomic variables including consumption C investment I and the real interest rate denoted r among others We are going to use FRED as our source of data many professional economists use this site nice clean data 1 I provide you with the links to the data that is needed throughout this assignment For an interesting look at the W vs the P see this graph from the FRED site As we move forward through the class we are going to learn about some business cycle facts See page 290 in text Chapter 8 In this first question among other things we are going to investigate the behavior of the real wage over the most recent business cycle See the National Bureau of Economic Research NBER site look at right hand side of page for the official dates of the most previous 4 recessions In particular we are going to calculate the percent change in the real wage during the most recent recession 12 07 6 09 and compare it to the percent change during the most recent recovery 7 09 to the present 1 FRED stands for Federal Reserve Economic Data see the FRED website 1 15 points total Use the following two links to answer the following questions Nominal Wages W Price index CPI P 2 Let us go back to the 1981 1982 recession review the NBER site Note that officially this recession began in third quarter of 1981 and ended in the fourth quarter of 1982 a 5 points Calculate the real wage W P the first month of the recession 7 81 and compare it to the last month of the recession 11 82 What is the percent change in the real wage during this most recent recession Please show all work and round to two decimal places W P 7 81 W P 11 82 W P b 5 points Now calculate the real wage during the first month of the recovery 12 82 and compare it to the real wage right before the following recession 6 90 What is the percent change in the real wage during this recovery thus far Please show all work and round to two decimals W P 12 82 W P 6 90 W P 2 Hint when deflating using a price index we typically move the decimal two place to the left For example in 12 09 W 18 80 and the price index was 217 541 The real wage is thus 18 80 divided by 2 17541 2 c 5 points What is the main reason why economists would like to use the real wage when looking at changes over time 2 10 points In the homework folder there are two items you need to answer this question One is a Ted Talk and the other is an NPR news story You can also access them via the links below https www ted com talks michael green what the social progress index can reve al about your country http www npr org templates story story php storyId 127586501 Why do economists use GDP to measure the wellbeing of society Is this the best way to do so Refer to the items above in discussing other ways to measure the overall wellbeing of a society 3 3 20 points You will need to use the following links to answer this question Nominal one year rates i Click Here Price index CPI P Click Here Expected Inflation Click Here In this part of question 2 we are going to compare the most recent one year real interest rates in the US both ex ante and ex post A couple notes are in order i Expected inflation data is one year hence so for example expected inflation for the period from July 2010 to July 2011 is given in July 2010 and if you view the data the expected inflation during this time is 2 7 e ii To calculate the actual rate of inflation for example during the July 2010 to July 2011 period you need to take the percent change in P P Using the CPI data we have the price index equaling 217 7 in 7 2010 beginning of August given the end of month data and 225 6 in 7 2011 end of July 2011 Note this is a 12 month period The actual rate of inflation during this time is 3 63 iii When using the one year nominal interest rate to calculate the all important real rate s of interest we need to be careful For example using the same one year time period July 2010 July 2011 we simply use the one year rate given as of July 2010 Think of buying the bond in July 2010 putting it in a safety deposit box or under your mattress a coffee can etc and then cashing it in when it matures in July 2011 you get your principal times whatever the nominal interest rate is In viewing the data the one year rate in July 2010 is 0 29 So clearly and by design of the Fed both the ex ante and ex post real rates are negative during this period and differ because expected inflation was not equal to actual inflation a 5 points Using the most recent data calculate the ex ante and ex post real interest rates Show your work Ex ante r Ex post r 4 b 5 points From a macroeconomic perspective why is deflation so bad Please refer to consumer behavior and the corresponding behavior of firms in a deflationary environment c 10 points Discuss the fact that persistent deflation is the central bank s worst nightmare Why is this environment such a nightmare for the central bank and monetary policy Explain using the Fisher equation for the real rate of interest and refer to both the ex post and ex ante real rate of interest 5 4 25 points Hy Marks buys a one year government bond on January 1 2011 for 500 He receives principle plus interest totaling 515 on January 1 2012 Suppose that the CPI is 200 on January 1 2011 and 206 on January 1 2012 This increase in prices is different than Hy had anticipated his guess was that the CPI would be at 201 by the beginning of 2012 a 5 …