In answering the questions below, refer to The Economics of Macro Issues text and
any other sources you choose. Be sure to provide thoughtful and comprehensive
answers.
1. Do you agree with the too big to fail concept? Should the Federal Reserve
have stepped in to avert the financial panic of 2008? What are the long run
implications of their actions?
The "too big to fail" concept suggests that certain financial institutions are so
critical to the functioning of the economy that their failure could have catastrophic
consequences. While this notion may seem reasonable on the surface, it can lead to
moral hazard, where banks take on excessive risk knowing that they will be bailed
out if they get into trouble. In the case of the 2008 financial crisis, several large
banks did indeed receive government support to avoid collapse. This action may
have prevented an even greater economic catastrophe, but it also reinforced the
perception that some institutions are immune to failure.
In my opinion, the too big to fail concept should not be embraced as a
permanent solution to financial instability. Instead, regulators should strive to
prevent banks from becoming too large and interconnected to fail and establish
mechanisms to manage the orderly resolution of failed banks without endangering
the broader economy. While the Federal Reserve's intervention in 2008 may have
prevented a deeper recession, it also set a dangerous precedent that could
encourage excessive risk-taking in the future.
The long-term implications of the government's actions in 2008 are difficult to
predict. Some argue that the bailouts prevented a systemic collapse and laid the
foundation for economic recovery, while others believe that they prolonged the
crisis by propping up failing institutions and preventing the necessary restructuring
of the financial sector. Furthermore, the interventions may have increased the
concentration of power in the hands of the largest banks, further exacerbating the
too big to fail problem. Ultimately, policymakers must strike a delicate balance
between preventing financial instability and avoiding the moral hazard that can
arise from government intervention.
2. What are the myths of Social Security as described in the book? How can
the system be fixed? (CH 21 and class notes)
One of the most common myths is that Social Security is going bankrupt and
will not be able to pay benefits to future retirees. In reality, the Social Security
Trust Fund currently has sufficient assets to pay full benefits until 2033, and even
after that, it would still be able to pay roughly 75% of benefits. Another myth is
that Social Security is a Ponzi scheme, where current workers pay into the system
to support current retirees, and future workers will pay into the system to support
them when they retire. While this may seem like a pyramid scheme, Social
Security is funded by payroll taxes and has a legal framework that makes it distinct
from a Ponzi scheme
To fix the Social Security system, policymakers have proposed various
solutions, including raising the retirement age, increasing payroll taxes, and
reducing benefits for high-income earners. However, these proposals are politically
challenging and may be insufficient to address the long-term financial
sustainability of the system. A more comprehensive solution would involve a
combination of policy changes, such as adjusting the inflation index used to
calculate benefit increases and expanding Social Security coverage to more
workers, as well as measures to increase economic growth and workforce
participation. Policymakers could also explore alternative sources of revenue, such
as a financial transaction tax or a carbon tax, to fund the system. Ultimately, fixing
the Social Security system will require a combination of political will and creative
policy solutions to ensure that future generations of retirees can receive the
benefits they deserve.
3. Why are healthcare costs so high in this country? What is the problem of
adverse selection and moral hazard as it relates to the Affordable Care Act?
(CH 17 and class notes)
Healthcare costs are high in the United States for several reasons. One major
factor is the high cost of medical technology and prescription drugs, which are
often more expensive in the US than in other countries due to factors such as patent
protection and regulatory barriers. Another contributing factor is the fee-forservice payment system, which incentivizes providers to order more tests and
procedures rather than focusing on preventive care or managing chronic
conditions. In addition, the fragmented nature of the healthcare system and the lack
of price transparency make it difficult for consumers to shop around for the best
value.
The problem of adverse selection and moral hazard is a key challenge for the
Affordable Care Act (ACA). Adverse selection occurs when people who are most
likely to need healthcare sign up for insurance, while healthy people opt out. This
can lead to higher premiums and reduced coverage for those who remain in the
insurance pool. Moral hazard occurs when people with insurance overuse
healthcare services because they are not paying the full cost, leading to higher
healthcare costs overall. The ACA attempts to address these problems through
measures such as the individual mandate, which requires most people to have
health insurance, and subsidies to make insurance more affordable for low-income
individuals. However, the effectiveness of these measures depends on factors such
as the cost of insurance and the availability of providers in each market. As the
healthcare system continues to evolve, policymakers will need to address the
challenge of balancing access to care with cost control.
4. What is more effective at generating economic growth, a tax rebate
(stimulus payments) or a decrease in the tax rate? Why?
The effectiveness of a tax rebate versus a decrease in the tax rate at generating
economic growth depends on several factors. In general, a decrease in the tax rate
may have a more sustained impact on economic growth, as it provides a permanent
reduction in the cost of labor and capital. This can lead to increased investment,
job creation, and productivity, which can drive long-term economic growth. On the
other hand, a tax rebate or stimulus payment may have a more immediate impact
on consumer spending, as people have more disposable income to spend on goods
and services. This can stimulate short-term demand and may be useful in
addressing a temporary economic downturn.
However, the effectiveness of these policies also depends on how they are
implemented and how they are financed. For example, a tax cut that is not
accompanied by spending cuts or revenue increases may lead to increased
government debt and higher interest rates, which can offset the positive impact on
economic growth. Similarly, a tax rebate that is funded by increased government
borrowing may lead to higher interest rates and crowding out of private
investment, which can also dampen economic growth. Overall, the effectiveness of
tax policies at generating economic growth depends on a complex interplay of
factors, and policymakers must carefully consider the trade-offs involved in each
approach.
5. How does the government finance increased spending? Depending on how
financed, what are the long run economic effects?
The government can finance increased spending through borrowing, printing
money, and raising taxes. Each of these methods has different implications for the
economy. Borrowing can lead to an increase in government debt, which may
reduce the government's ability to invest in the future and can lead to higher
interest rates that can crowd out private investment. Printing money can cause
inflation, which reduces the value of money and can lead to higher interest rates,
lower investment, and reduced economic growth. Raising taxes can reduce
disposable income and discourage investment and entrepreneurship, but it can also
help to reduce government debt and improve the sustainability of government
spending.
The long-run economic effects of financing increased spending depend on how
the spending is financed. If the spending is financed through borrowing or printing
money, it can lead to higher inflation, higher interest rates, and reduced economic
growth over the long term. On the other hand, financing increased spending
through raising taxes can have a positive effect on the economy over the long term
by reducing the burden of government debt and improving the sustainability of
government spending. Ultimately, the choice of how to finance increased spending
should consider the short-term and long-term implications for the economy, as well
as the distributional effects of each option.
6. What is moral hazard as it relates to the “Too Big to Fail” concept? How
does this philosophy prevent creative destruction?
Moral hazard refers to the tendency of individuals or institutions to take on
greater risks when they are insulated from the potential consequences of those
risks. In the context of the "Too Big to Fail" concept, moral hazard arises when
large financial institutions are perceived as being guaranteed a government bailout
in the event of a crisis. This can lead these institutions to take on excessive risk, as
they do not bear the full costs of their actions. In turn, this can lead to a situation
where these institutions become "Too Big to Fail," as their failure would have
systemic implications for the entire financial system. This can prevent creative
destruction, which is the process of inefficient firms being replaced by more
efficient ones, as large firms may be shielded from the consequences of their
actions, making it difficult for smaller, more efficient firms to compete on a level
playing field.
7. How has the Fed’s implementation of monetary policy changed in recent
years? What are the implications of this change?
In recent years, the Federal Reserve has implemented a more aggressive
monetary policy in response to the 2008 financial crisis. This has included
lowering interest rates to near zero, engaging in large-scale asset purchases through
quantitative easing, and shifting towards forward guidance. The Fed has also taken
a more proactive role in financial regulation, particularly with respect to systemic
risk. The implications of these changes are complex, with potential benefits for
economic growth and financial stability, but also concerns about inflation,
financial imbalances, and the politicization of monetary policy. Overall, the
changes reflect a desire to more effectively manage the challenges of a rapidly
changing economic environment.
8. What is the downside, even with a fully functional digital wallet system in
place, of never carrying any cash with you? (CH 25)
One downside of never carrying any cash with you, even with a fully functional
digital wallet system in place, is the potential for technological failures or
disruptions. A digital wallet relies on electronic systems to process transactions,
which can be vulnerable to hacking, glitches, or other forms of technical
malfunctions. This can lead to situations where individuals are unable to access
their funds or make purchases, particularly in areas with limited or unreliable
internet connectivity. Additionally, reliance on digital payment systems may lead
to issues with privacy and security, as personal financial information is stored and
transmitted electronically. In sum, while digital wallet systems offer convenience
and efficiency, they are not foolproof and may present certain risks and challenges
that should be considered.
9. Briefly discuss the use of fiscal policy verses monetary policy as a means of
smoothing economic cycles.
Fiscal policy and monetary policy are two tools that governments use to smooth
economic cycles. Fiscal policy involves changes in government spending and
taxation, while monetary policy involves changes in interest rates and the money
supply. Fiscal policy can be used to directly affect aggregate demand, through
changes in government spending and taxation, and can be targeted to specific
sectors or groups. However, fiscal policy can be slow to implement and subject to
political constraints. In contrast, monetary policy can be implemented quickly and
is generally free from political influence, but may be less effective in targeting
specific sectors or groups. Ultimately, the effectiveness of each policy tool depends
on the specific economic context and the goals of policymakers. A combination of
both fiscal and monetary policy may be most effective in smoothing economic
cycles and achieving desired outcomes.