Macrosimulation: What to do in stagflation?

• Intended for a principles of macroeconomics course after students have learned about fiscal and monetary policies. In particular students should have prior understanding of income taxes, payroll taxes, investment tax credit, reserve requirements, open market operations, federal discount rate and interest rate on reserve accounts.

• Making and evaluating the choices will take about twenty minutes. The exercise can be continued in various ways (see below on teaching notes) in which the simulation is continued beyond the first year.

Overview

• Based on an online macroeconomic simulation for an economy with stagflation, teams choose from a selection of fiscal and monetary policies for one year. The simulation then shows the results of the choice that can be prelude to students running the simulation for ten years. By practicing with these fiscal and monetary policy choices students learn their likely effect on the economy. In addition, students must make decisions about the relative importance of economic measurements including unemployment, inflation, GDP growth and the federal deficit.

Expected Student Learning Outcomes

• By practicing with these fiscal and monetary policy choices students learn their likely effect on the economy. In addition, students must make decisions about the relative importance of economic measurements including unemployment, inflation, GDP growth and the federal deficit.

Information Given to Students

You are in charge of fiscal policy and monetary policy for a country that faces the following

Real GDP Growth -2%
Unemployment Rate 8%
Inflation Rate 8%
Federal Government Deficit $300 Billion
Prime Interest Rate 12%

Which set of fiscal and monetary policies is most appropriate in this situation?

A) Government Spending – Military +5%
Government Spending – Infrastructure +5%
Income tax change -5%
Payroll tax rate change -5%
Investment tax credit
Reserve requirement
Open market operations
Interest rate on bank reserves
Discount rate

B) Government Spending - Military
Government Spending - Infrastructure
Income tax change
Payroll tax rate change
Investment tax credit
Reserve requirement +5%
Open market operations -5% (sell)
Interest rate on bank reserves +5%
Discount rate +5%

C) Government Spending – Military +10%
Government Spending – Infrastructure +10%
Income tax change -10%
Payroll tax rate change -10%
Investment tax credit +10%
Reserve requirement +10%
Open market operations -10% (sell)
Interest rate on bank reserves +10%
Discount rate +10%

D) Government Spending – Military +5%
Government Spending – Infrastructure +5%
Income tax change -5%
Payroll tax rate change -5%
Investment tax credit +5%
Reserve requirement +5%
Open market operations -5% (sell)
Interest rate on bank reserves +5%
Discount rate +5%

E) Government Spending – Military -5%
Government Spending – Infrastructure -5%
Income tax change +5%
Payroll tax rate change +5%
Investment tax credit -5%
Reserve requirement -5%
Open market operations +5% (buy)
Interest rate on bank reserves -5%
Discount rate -5%

This activity is based on an online simulation available here. After students have debated about their policy choices, enter any policy choices in the simulation to reveal how the simulation models the next year in the economy. Note to students that it is, of course, only a simulation based simplified equation assumptions. Such models are used by macroeconomists. Results are as follows;
A) Real GDP Growth 0%
Unemployment Rate 6%
Inflation Rate 9%
Federal Government Deficit $570 Billion
Prime Interest Rate 10%

B) Real GDP Growth -2%
Unemployment Rate 9%
Inflation Rate 5%
Federal Government Deficit $350 Billion
Prime Interest Rate 10%

C )Real GDP Growth 1%
Unemployment Rate 4%
Inflation Rate 6%
Federal Government Deficit 770 Billion
Prime Interest Rate 10%

D) Real GDP Growth 0%
Unemployment Rate 6%
Inflation Rate 7%
Federal Government Deficit $585 Billion
Prime Interest Rate 10%

E) Real GDP Growth -3%
Unemployment Rate 10%
Inflation Rate 9%
Federal Government Deficit $115 Billion
Prime Interest Rate 10%

There are several possible follow-up activities.

1. Students can run the simulation outside of class individually or in small teams (pairs may be best), submitting an analysis as assessment (see below on assessment questions).

2. In class the simulation can be run for later years. Teams may be selected an random to make a year's decisions. Other teams can vote on what they expect to happen to each of the economic variables as a result of the policymaking team's decisions

In this case teams will vote for each policy decision:

• GDP growth will A) increase B) decrease C) stay the same
• Unemployment will A) increase B) decrease C) stay the same
• Inflation will A) increase B) decrease C) stay the same
• The deficit will A) increase (become more negative B) decrease (become less negative) C) stay the same

Simulation predictions (Microsoft Word 2007 (.docx) 12kB Jan28 18)