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Chapter 26: Q.10 (page 691)

From mid-2008 to early 2009 , the Dow Jones Industrial Average declined by more than 50%, while real interest rates were low or falling. What does this scenario suggest should have happened to investment?

Short Answer

Expert verified

Low genuine loan fees decrease the expense of funding speculation and, thus, empower venture spending

Step by step solution

01

Step 1. Concept of Dow Jones industrial average 

Instead of the number of stocks in the average, the Dow Jones industrial average is the proportion of the sum of components of stock prices divided by the divisor. Tobin was the first to describe the relationship between stock market and investment, and his explanation is known as Tobin's q.

02

Step 2. Explanation

Low real interest rates reduce the cost of financing investment and, as a result, encourage investment spending. When the stock market falls, the market valuations of the companies fall, and Tobin's q falls as well. The decrease in Tobin's q would result in a decrease in investment spending. Because of the massive collapse in Tobin's q and the stock market, investment spending dropped dramatically at this time.

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Most popular questions from this chapter

Following the global financial crisis, mortgage rates reached record-low levels by 2013 and again in 2016 .

a. What effect should this have had on the economy, according to the household liquidity effect channel?

b. During much of this time, most banks raised their credit standards significantly, making it much more difficult to qualify for home loans and to refinance existing loans. How does this information alter your answer to part (a)?

How does the Great Depression demonstrate the unanticipated price level channel?

Suppose the economy is in recession and the monetary policymakers lower interest rates in an effort to stabilize the economy. Use an aggregate supply and demand diagram to demonstrate the effects of a monetary easing when the transmission mechanisms are functioning normally and when the transmission mechanisms are weak, such as during a deep downturn or when significant financial frictions are present.

1. Go to http://www.econlib.org/library/Encl/Recessions . html and review the material on recessions.

a. What is the formal definition of a recession?

b. What are the problems with the definition?

c. What are the three Ds used by the National Bureau of Economic Research (NBER) to define a recession?

d. Review Chart 1. What trend is apparent regarding the length of recessions?

"The costs of financing investment are related only to interest rates; therefore, the only way that monetary policy can affect investment spending is through its effects on interest rates." Is this statement true, false, or uncertain? Explain your answer.
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