MBA 613: ECONOMIC POLICY AND THE GLOBAL ENVIRONMENT

Fall 2008

Stuart Allen stuart_allen@uncg.edu

462 Economics Department Office hours: By appointment, after class
334-3166 http://www.uncg.edu/eco/people/allen

CATALOG DESCRIPTION
Prerequisite: MBA 603 (1.5 hours)
Economic theory analyzes short-run and long-run effects of domestic fiscal, monetary and exchange rate
policies and the international consequences of global policy changes on the domestic economy.

OBJECTIVES
The major objective of this course is to develop your economic understanding and analytical ability to
understand the current macroeconomic data and policy discussions provided by business publications and
other media. The course will utilize aggregated markets such as the output, labor, credit/financial, bank
reserve, money and foreign exchange markets to analyze the effect of changes in monetary, fiscal and
exchange rate policy in the context of the global economy. The lectures, discussions, readings and
assignments will help to develop your ability to analyze the current economic environment, evaluate current
government policies, and responses to the risk that accompanies the uncertain economic environment facing
firms. Historical case studies will also be employed to explain the development of the current global and
international economic and financial system.

COURSE MATERIALS
Allen, Manuscript, available at the UNCG Bookstore only.
Dolan, Introduction to Macroeconomics, 3rd edition, available at the bookstores.

ADDITIONAL SOURCE MATERIAL

The Wall Street Journal, Business Week, and The Economist provide analysis about economic data, the
domestic and world economy, and public policy.
• Check out government agencies such as CBO.gov, BEA.gov, and BLS.gov for additional
information. The Federal Reserve Corner is at http://www.nabe.com/publib/fed.html
• Political economic analysis of Paul Krugman and Brad DeLong and tax analysis of the Tax
Foundation may be of interest. (Google)

COURSE REQUIREMENTS (CLASS AUG. 28, SEPT. 4, 11, 18, 25 AND OCT. 1 AND 8)

Test 1 – 20% – Class 3 – Sept. 11

Test 2 – 30% – Class 5 – Sept. 25
Final Exam – 50% – Class 7 – Oct. 8

A higher final exam score may be substituted for only one of the two test grades.

LAST DAY TO DROP CLASS WITHOUT PENALTY: SEPTEMBER 19

HONOR POLICY
Students are expected to comply with the UNCG Honor Policy:
http://academicintegrity.uncg.edu/complete/
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GRADING POLICY AND SCALE

Incompletes are not an option. No extra credit.
A: 90 - 100 B: 80 - 89 C: 65 - 79 F: Less than 65

FACULTY STUDENT GUIDELINES

Can be found at http://www.uncg.edu/bae/faculty_student_guidelines.pdf

ATTENDANCE
Attendance is necessary. Missing class may be hazardous to your course performance. If the unexpected
happens and you have to miss class, you are responsible for the night’s material. If you miss a test the weight
of the test will be added to the 40% weight of the final exam. You may tape record the classes.

BACKGROUND KNOWLEDGE
Most students will have little background or retention of macroeconomics and financial markets. There will
be a minority of students who will have working knowledge of the course from their undergraduate course
work. This course is meant to challenge all students regardless of one’s background, with the goal of every
student gaining significant insight into the workings of the macroeconomic system.

CLASS TIME
Lectures and class discussions will integrate economic theory, economic history, and graphical analysis with
your questions of clarification and inquiry. A mixture of questions and inquiry makes for an interesting class
environment for both the students and the instructor. You are encouraged to tape record the class (if this is
useful for you) and to rewrite your class notes. Reading the assigned readings is extremely important prior to
each class. The class meets from 6:30 – 9:20.

WEATHER POLICY
If we miss a night due to weather, etc. the class time will be made up. Please check Blackboard for an
announcement.

OVERVIEW OF THE MANUSCRIPT

CHAPTERS 1-2: The domestic and global economic system is analyzed through a circular flow model that
includes an output, labor, credit, money and foreign exchange market. This macroeconomic model provides
the framework for interpreting economic data, analyzing short-run economic fluctuations, and predicting
outcomes from monetary and fiscal policy changes.

CHAPTERS 3-5: These chapters introduce and develop the output and labor markets that allows for the
analysis of short-run economic fluctuations and the possible trade-off between inflation and unemployment.

CHAPTERS 9-10: The effect of the Federal Reserve's monetary policy on economic activity and the rate of
inflation are considered. The Fed's role in fighting inflation in the late 1970s and early 1980s, the resulting
disinflationary environment and low inflation decades of the 1980s and 1990s are examined. The Federal
Reserve use of interest rate targeting is analyzed.

CHAPTER 11: The effect of fiscal policy defined as government expenditure and tax policy on short-run
fluctuations and long-run economic growth are considered. The debate over appropriate fiscal policy and the
effect from federal budget deficits are discussed.

CHAPTER 13: The evolution of the international financial system from the gold standard and its collapse
during the 1930s to the Bretton Woods system and its collapse in the early 1970s is discussed. The
adjustment process for the deficit-prone and surplus-prone countries in the Bretton Woods system is a major
topic as it will provide a framework for understanding China’s policies.
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HOW TO GET STARTED PREPARING FOR THIS COURSE

This class represents a combination of evening students and new day-time full-time students. Evening
students should have had ECO 603. Day-time students should read and study Dolan’s first introductory
chapter and his second chapter that reviews supply and demand analysis.

The Circular Flow Model in Chapter 2 of the manuscript provides a visual model of the important economic
exchanges that occur in a domestic economy (no foreign trade) as illustrated by:

1) The exchange of all resources (inputs) between households (assumed to own all resources either directly or
indirectly through ownership of common stock). The most important input market is the Labor Market. The
unemployment rate is a popular measure of how well we are doing in the labor market but even more
important is the rate at which new jobs are created in the economy.

2) The output market represents the exchange of production of all final goods and services by domestic
producers (firms) and the expenditures by the household, business and government sectors. Aggregate supply
represents the production side and aggregate demand represents the expenditure side of the output market.
The value of the total production in the output market is nominal GDP. The two axes of the output market
represent real GDP (output) and the price level in the overall economy. The percent change of real GDP is
economic growth while the percent change of the price level is inflation (positive growth).

3) The credit market represents the exchange of credit between savers (supply curve) and borrowers (demand
curve). The price of credit is the interest rate determined by the interaction of borrowers and savers.

Students should consider the factors that shift the demand and supply curves in the labor, output, and credit
markets and the resulting impact in the equilibrium price and quality in each market.

Chapter 1 in the manuscript and Chapters 4, 5, and 6 in the Dolan text deal with the three key macroeconomic
variables (outcomes): unemployment, economic growth, and inflation with important historical references.
Chapter 3 in the manuscript, and Chapter 6 in the Dolan text, deals with the nuts and bolts of measuring
economic activity. They key issue is how to compute real GDP and the price level from nominal GDP.

You should also think about the concept of potential (full employment) real GDP and the full employment
unemployment rate. Diagramming the level of potential full employment real GDP and actual real GDP will
provide information about whether the economy is in a recession, or expansion, and whether inflation may be
a problem. Such information is necessary to consider what policy change should occur with regard to
monetary and fiscal policy.
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LEARNING OBJECTIVES

Students should be able:

1. To understand the measurement of macroeconomic data such as real GDP, economic growth, price
indexes, inflation, unemployment, employment, the federal budget deficit, and the national debt.

2. To be able to convert (deflate) nominal variables to real variables.

3. To understand the measurement of a country’s balance of payments, the current and capital accounts
and the status of a country as a debtor or creditor nation.

4. To understand the role of exchange rates in equilibrating trade and financial flows.

5. To discuss the sources of economic growth for developed and developing countries.

6. To analyze the effect of each of the three macroeconomic policies (fiscal, monetary, and exchange
rate) with regard to real GDP growth, the unemployment rate, and the rate of inflation.

7. To analyze the effect of shifts in aggregate demand and aggregate supply in the output market in
terms of short-run fluctuations in economic activity.

8. To analyze the effect of implementing expansionary and contractionary policy when the economy is
suffering from recession or inflationary pressure.

9. To analyze the short- and long-term effects on real GDP growth and the inflation rate from the
expansionary monetary policy of the late 1970s and Volcker’s fight against inflation from 1979-82.

10. To analyze the conduct of monetary policy (e.g. federal funds interest rate targeting) with specific
reference to the interest rate targeting of the 1970s, the 1990s and the 2000s.

11. To analyze monetary policy according to Taylor’s rule.

12. To analyze the effects on economy activity and economic growth from fiscal policy and deficit
spending with specific reference to the Reagan budget deficits.

13. To analyze the effect of the 1980s budget deficits and monetary policy on real interest rates, the
current account deficit, the value of the dollar and the status of the US as a creditor or debtor nation.

14. To understand the Bretton Woods international financial system and the adjustment process.

15. To analyze the Asian currency crisis in 1997/98 and the role of fixed exchange rates in the boom
and bust cycle.

16. To analyze the current exchange rate policy of China.

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MBA 613
Course Outline
Chapters 4 – 6 in the text book (D) correspond to Chapters 1 – 3 in the manuscript (M). The key organizing
principle is the circular flow diagram in Chapter 2 of the manuscript that depicts the economic exchanges in a
simple three market macro economy. Chapter 6 in the textbook and Chapter 3 in the manuscript have
considerable detail about how nominal GDP, real GDP and the price level are computed.

Section I-IV: Classes 1 and 2

I. Economic Data

A. Long-Run Economic Growth (Output) (Real GDP) D pp. 95-100

B. Short-Run Fluctuation in Real DGP D pp. 101-103

1. Business Cycle: Expansion and Recession D pp. 101-103
2. Employment and Unemployment D pp. 103-110
3. Price Stability and Inflation D pp. 110-114

To Do Section:
Go to NBER.ORG and record the dates of the last nine recessions. What is the average length of these
recessions?
Go to BLS.ORG and click on the National Employment link under Employment and Unemployment.
Read the FAQ. What are the current unemployment and employment rates? What was the lowest
level of unemployment in the 2002-2008 expansion? What were the highest employment rates during
this same period?
Go to BEA.GOV and read the first two pages of the latest GDP news release.

C. Potential (Full Employment) Real GDP M Ch. 1 p. 7-12

D. Price Stability and Inflation

Go to BLS.ORG and check on: Consumer Price Index, Inflation and Consumer Spending. What was
the average inflation rate in 2004, 2005, 2006, and 2007 according to the CPI?

E. Digression: Three Macroeconomic Policies M Ch. 1, pp. 15-18

1. Fiscal Policy
2. Monetary Policy
3. Exchange Rate Policy

Key Policy Questions: Understand the Separate Roles of the Treasury and the Central Bank (Section II & III D)
1. What is the role of the Treasury and the Federal Reserve Board with regard to fiscal and monetary
policy?
2. What are the effects on interest rates and the money supply from the Treasury and the Federal
Reserve Board’s operations in the bond market?

F. Summary
3 Economic Goals
3 Economic Policy Variables
3 Positions for the Economy
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II. The Circular Flow Model of Income and Product D, pp. 119-124
M2, pp. 1-30
A. Two-sector Two-market Model
B. Input Markets: Labor Market (example)
C. The Output Market: Aggregate Supply and Demand D10, pp. 231-243
D. Government (Third Sector)
1. How Does a Government Obtain Resources?
2. Fiscal vs. Monetary Policy
E. Savings/Investment (The Credit/Financial Markets)
1. Consumption vs. Savings
Read: “Leapfrog” Article
2. Present vs. Future Oriented Policy
E-Reserves “When nations play leapfrog,” The Economist, Oct. 16, 1993, p. 84. (Section III E) [Class 1]
Questions:
1. Why have the NICS grown at a faster pace than when Britain and the U.S. first industrialized?
2. What evidence is provided regarding investment (savings) rates in Britain, the South Korea?
3. What forms did the investment take in East Asia?
4. What role has globalization played in the rapid rate of NIC growth?
5. Will economics converge in terms of economic rates of growth?

III. Measuring Economic Activity D6, M3

A. National Income Accounts (Nominal Terms)

B. Measuring International Linkages
C. Measuring Real GDP and the GDP Deflator
D. The CPI vs. GDP Deflator: Two Measures of Price Indexes
E. The Foreign Sector (Foreign Trade) D6, pp. 145-149
1. Current Account
2. Capital Account
F. Case 1: Trade Deficit Causing a Declining Currency
G. Case 2: Trade Deficit as a Result of a Rising Currency

The Foreign Sector (International Trade and Exchange)

Questions:
1. Define the current and capital accounts by the type of transactions recorded in each.
2. Why is a current account deficit (surplus) offset by a capital account surplus (deficit)?
3. What does it mean in terms of wealth when a country has a capital account deficit?
4. Under what conditions would a country have a current account deficit and a weaker
currency? Why would the current account deficit be eliminated by the weaker
currency?
5. Under what conditions would a country have a current account deficit and a rising
currency? What conditions are necessary for a country to continue to have a current
account deficit and a rising currency?
6. Read E-Reserves, Welch article, “A matter of exchange rates,” 1994.

IV. The Output Market: AD and AS D10, M5

A. Aggregate Demand (AD)

B. Aggregate Supply (AS)
C. Long-run AS vs. Short-run AS
D. Long-run vs. Short-run Equilibrium
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E. Recession: Need for Expansionary Policy

F. Inflation: Need for Contractionary Policy
G. Static vs. Dynamic Analysis of the Output Market

V. The Labor Market M4

A. Connection between Output and Labor Markets

B. The Natural Rate of Unemployment and Potential Real GDP
C. Assumption of Wage Flexibility: Outcomes
D. Assumption of Wage Rigidity: Outcome

Test 1: September 11

VI. The Federal Reserve and Monetary Policy

A. The Federal Reserve and the Money Supply D7-9, M9-10

1. The Fed and the Monetary Base
2. The Fed and the Role of the Banking System in Money Creation
3. The Money Multiplier
4. The Federal Fund Rate and the Reserve Market
Optional web site entitled U.S. Monetary Policy: An Introduction at
http://www.frbsf.org/publications/federalreserve/monetary/index.html

B. Monetary Policy and Economic Activity, Manuscript Chapter 10

1. The Model: The Effect from a Monetary Overexpansion
2. Three Interest Rate Effects
3. Pro-cyclical Targeting in the 1970s: The Carter Inflation
4. Volcker’s Disinflation: 1979-1982
5. The Effect on Third World Countries from the Fight Against Inflation

E-Reserves
“The Federal Reserve and Monetary Instability,” The Wall Street Journal, February 1, 1982
“How Federal Reserve Under Volcker Finally Slowed Down Inflation,” The Wall Street
Journal, December 7, 1984, p. A1.

C. Greenspan: Taylor’s Rule

1. The 1990-1992 Decline in the Federal Funds Rate to Fight the Recession
2. Maintaining a 3% Federal Fund Rate in late 1992 through January 1994
3. The Fight Against Inflation in 1994 - The Quick Response
4. The Rapid Easing: 2001-2002 and Negative Real Rates: 2002-2004
5. 2004-2006 Raising Nominal and Real Rates

Test 2: September 25

VII. The Role of the Central Bank in Maintaining Fixed Exchange Rates M13

A The Gold Standard

B. Fixed Exchange Rates
C. The Bretton Woods System
D. Pegging to the Dollar: The Asian Currency Crisis: 1997-1998
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Questions:
1. Explain how current account deficits and surpluses are eliminated in a gold standard.
2. Diagram and explain the dilemma faced by current account deficit (surplus) prone countries
under Bretton Woods.
3. Explain the term “imported inflation.”
4. Explain the Asian currency crisis in terms of the boom cycle when the currency is
undervalued and the bust cycle when the currency is overvalued.

E-Reserves, “Who’s Really Pounding Asian Economies,” Business Week, September 22, 1997.
Questions from the reading
1. What role did the decision of the East Asian tigers to peg their exchange rate with the dollar
have on the boom period of 1993-95/I and their current account surpluses?
2. Explain (and diagram) why there was excess money created in those countries pegged to the dollar.
3. After China devalued in 1994 and the yen depreciated after 1995/I, what began to happen to
the tiger’s current account balance?
4. Why could the tigers not maintain a fixed exchange rate with the dollar in 1997?

E. The Chinese Exchange Rate Policy

VIII. Fiscal Policy D11-12, M11

A. A Brief History of National Policy Towards Deficit Spending

1. The Classical Fiscal Principle
2. First Shift in Fiscal Policy: 1946 - 1960
B. Second Shift in Fiscal Policy - Keynesian Economics: 1961 - 1980
1. Discretionary Fiscal Policy: Short-run Stabilization Policy
2. Deficit Spending, Crowding Out and Crowding In
3. An Analysis of the Kennedy Tax Cuts
C. Third Shift in Fiscal Policy - Reaganomics (Supply-side Economics)
1. 1981 Tax Cut - Spur Savings and Investment
2. The Twin Deficits and the Crowding Out of the Trade Sector D p. 119, p. 287
E-Reserves, “How Reagan Recast Debate…,”
D. Fourth Shift in Fiscal Policy?
1. 1986 Tax Bill and the 1990 Tax Increase and Budget Surplus
2. Clintonomics: 1993 Tax Increase and Budget Surplus
E. Fifth Shift in Fiscal Policy (Bush 2001-2006)

IX. Recent Economic History

A. OPEC Embargo
B. Monetary Policy and Inflation 1975-1982 M10
C. Volcker’s Fight against Inflation M10
D. Reaganomics 1981-1989 M11
E. Twin Deficits
F. Fiscal Policy under Bush, Clinton and Bush
G. Greenspan 1987-2006 and Taylor’s Rule
H. Fiscal-Monetary Policy Mix: 2006-2008
I. Global Imbalances
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QUESTIONS TO REVIEW FOR THE FINAL

1. Analyze the current state of the U.S. economy with regard to economic growth, employment,
unemployment, wages, inflation, interest rates, and exchange rates. What is your prediction for
inflation and economic growth next year? Is the U.S. in a "new economy" paradigm?
2. Explain the economic situation that could cause a country to have a current account deficit and a
falling or rising exchange rate. What historical episodes can you provide for each case?
3. Why did the U.S. become a debtor nation in the 1980s? Why is this statement debatable?
4. Why should the Treasury and the Central Bank of a country be separate institutions? Relate to the
case of Russia in the 1990s or other countries as may be appropriate?
5. Discuss Okun’s Law with regard to the full employment rate of real GDP growth in the U.S.
economy. Is the economy at full employment? Can the unemployment rate fall further? Why or
why not?
6. Discuss the Phillips curve relationship and inflationary pressure in the 1990s. Is there a New
Economy that has ushered in a new relationship between inflation and the business cycle.
7. When and why would you finance a home with a fixed or variable interest rate at this time?
8. Is the large current account deficit an indication of possible future currency devaluation? What
risks does this create for international investors? What risks are there for bond investors?
9. Examine the role of the Federal Reserve System in affecting economic activity, interest rates,
inflation rates, and short-run economic growth.
10. Compare and contrast interest rate targeting conducted by the Federal Reserve in the 1970s versus
the 1990s and the 2000s. Contrast the pro-cyclical versus counter cyclical interest rate targeting
procedures and explain when the Fed used each targeting process.
11. Analyze the policies of the Federal Reserve when Volcker was fighting double-digit inflation.
Include in your discussion the three-interest rate effects from major changes in Fed policy.
12. Explain who wins and who loses when inflationary expectations are greater than (less than) actual
rates of inflation.
13. How would your estimate of inflationary expectations affect your investment philosophy?
14. What effect did Volcker's anti-inflationary policies have on Third World countries in the early
1980s?
15. Analyze the policies of the Federal Reserve according to Taylor’s Rule and the effect of these
policies on the underlying rate of inflation. Analyze monetary policy in 1991-93 versus 1994-95
and use the appropriate output market diagram to show the initial and final position of the economy.
16. Analyze the monetary policy changes in 2000-2006 with respect to Taylor’s Rule. What is the
prospect for future changes in interest rates given the current state of the U.S. and global
economies?
17. Analyze the effect of government fiscal policy and large budget deficits on long-term economic
growth and the competitive position of the U.S..
18. Examine the movement of real interest rates during the 1970s and 1980s. What happened to the
value of the dollar in the first half of the 1980s and what was the impact on U.S. manufacturing?
19. Explain the boom and bust cycle that caused the Asian Currency Crisis in 1997 and the role that
exchange rate policy had in this boom and bust scenario.