WORKING WITH MACROECONOMIC DATA

For data to use in these exercises, go to the Federal Reserve Bank of St. Louis FRED database at fred.stlouisfed.org.

1. Keynesian theory predicts that expansionary fiscal policy—either higher spending or lower taxes—will raise the real interest rate.

Using data since 1960, graph the Federal govern­ment budget deficit, the state-local government bud­get deficit (both relative to GDP), and the real interest rate (three-month Treasury bill rate minus the CPI inflation rate over the preceding twelve-month period).

Do you see a link between deficits and real interest rates? In what period does the relationship seem clearest? Do your answers change when the ten-year government bond interest rate is used instead of the three-month rate?

2. Because of price stickiness, the Keynesian model pre­dicts that an increase in the growth rate of money will lead to higher inflation only after some lag, when firms begin to adjust their prices. Using data since 1960, graph the inflation rate and the rate of growth of M2. Prior to 1980, is it true that increases in money growth only affected inflation with a lag? What has happened since 1980?

Keynesians argue that financial innovations, such as the introduction of money market deposit accounts at banks, led to a large increase in the demand for M2 in the early 1980s. If this claim is true, how does it help explain the relationship between money growth and inflation that you observe after 1980?

3. Working with Macroeconomic Data Exercise 1, Chapter 10, asked you to look at the cyclical behavior of total factor productivity. If you have not completed that problem, do it now and compare productivity changes with changes in the producer price index for fuels and related products and power. How would Keynesian interpretations differ from those offered by classical macroeconomics?

4. The theory of macroeconomic stabilization policy in this chapter provides a playbook for monetary policy. When the economy is weak, the Federal Reserve eases monetary policy by increasing the money sup­ply and reducing the real interest rate. When the economy is strong and inflation is rising, the Federal Reserve tightens monetary policy by reducing the money supply and raising the real interest rate. To test whether the Federal Reserve has followed this playbook, get data from FRED on the federal funds interest rate and on expected inflation from the University of Michigan survey of consumers. From those two data series, calculate and plot the real inter­est rate since 1990. Does the real interest rate usually decline in recessions? Does the real interest rate usu­ally rise as economic expansions are under way?