EC365 Final Exam Prep PDF

10 questions, answer 6 out 7 4 out of 5 Always pick a side for a question to receive full points Look at slides then look at assignments Harder than the midterm in terms of grading on what you wrote not so much as challenging questions Review graphs - explain each axis 1. What were the “juros” i...

10 questions, answer 6 out 7 4 out of 5 Always pick a side for a question to receive full points Look at slides then look at assignments Harder than the midterm in terms of grading on what you wrote not so much as challenging questions Review graphs - explain each axis 1. What were the “juros” in the reign of Philip II of Spain? Why were they a safe asset for investment? Government bonds issued by the Spanish crown Main debt was perpetual annuities (juros) Why they were safe: ○ Spanish crown promised to pay back the money → bond felt secure ○ Crown payed interest on the bonds from income of the colonies in US ○ Spain regularly issued them to raise money b/c Philip II needed money for wars and other expenses → investors believed these bonds would be repaid ○ Strong government (trust with people) ○ Stable and easier to trade because they were around all of Europe 2. Some have suggested that when Philip II stopped payments on the loans by Genoese bankers in 1575, that was a standard case of sovereign debt default in which the sovereign defaults on foreign bankers. While the sovereign (Philip II) did halt payments to foreign bankers it was a strategic financial maneuver to renegotiate debt terms rather than a complete rejection The kings debt crisis led to restructuring negotiations not an outright refusal to honor negotiations - makes it different from a usual sovereign default John Law - All finances and issuance of money in one private company under John Law - Views all credit is trade credit - Doctrine of real bills - paper money could be issued safely if it was backed by short term self liquidating loans (real bills) - In charge of monetary policy, collection of laxes, and all external trade 3. Was there any writing by John Law before he started his experiment that could provide an indication about his main ideas? John Law: Scottish economist and financial theorist, is best known for his role in the establishment of the Mississippi Company and the creation of France's paper money system in the early 18th century (ultimately failed) ○ Main argument: too little liquidity in economy ○ First idea: the state should manage the monetary policy ○ Argues that paper money backed by assets like land could replace gold and silver and that the right management of these instruments could stimulate economic growth and increase national wealth 4. Present the fundamental idea behind the system of John Law in about 10-15 lines. Go to the main point. John Law's economic system was built around the idea that paper money and credit could drive economic growth. He believed that wealth was not tied to gold or silver but to the ability to generate trade and investment. Law proposed that the government could issue paper currency backed by assets like land to create a flexible money supply. This paper money could encourage investment, funding public works, and facilitating trade. He also advocated for the creation of a central bank to regulate the money supply and manage credit. Law’s system relied on credit expansion to increase liquidity and economic output, allowing the state to issue debt to finance large projects without depleting physical resources. 5. Present (or imagine) conditions under which his experiment could have worked. Controlled money supply: gradual issuance of paper money and carefully regulated to avoid inflation Real asset backing: the paper currency needed to be backed by productive, value generating assets Public confidence: maintaining trust in the currency and the financial system to prevent panic and collapse 6. Compare the policy decisions in France about the default on the debt and Estates Generals in 1716 and 1788 (or 1789). 1716: →France under Louis XV ○ Financial crisis due to war debts and mismanagement ○ Government influenced by John Law’s system → defaulting on national debt ○ Law’s policies included the creation of the Mississippi Company and issuance of paper money → led to inflation and public distrust ○ No Estates Generals called → (church + nobility against third estate), argue that the problem is of the previous administration 1788: → France under Louis XVI ○ France debt worse under ongoing wars (American Revolution) ○ Summoned Estates General for the first time since 1614 hoping to address fiscal crisis and reform taxation → deal with public debt ○ Led to widespread demands for systemic change fueling the French Revolution and ultimately led to fall of the monarchy 7. What did the system of John Law and assignats have in common? What was the difference? Similarities: ○ Paper money ○ Aimed to solve debt problems through Mississippi Company and Church land ○ Backed by assets but suffered from over-issuance leading to inflation and loss of confidence → ended in failure  Differences: ○ Law: system was speculative, relying on future value of Mississippi Company and trade in Americas Experiment was broader financial modernization ○ Assignats: backed by real land but issued during French Revolution for urgent financing Revolutionary emergency measure 8. The following figures describe events during the period of the assignats. (You are supposed to know the meaning of these figures). (a) Using the figures, comment on the quantity and prices of the assignats during the period of the Terror. During the period of the Terror the nominal value of assignats increased rapidly showing a significant issuance of new currency in Figure 1 BUT the real value of assignats declined in Figure 2 → means severe inflation and loss of purchasing power The “Terror” period the issuance of assignats rapidly increased and the real value was above the gold value since the economy was trying to adjust IN CONCLUSION: Supply of assignats grew, but their value in terms of real goods and gold plummeted due to economic instability and overissuance These rising and falling values demonstrate the unstable paper currency during revolution periods and even more when they are not supported by a stable asset like gold. The quick decline at the end of the real value and gold value reflects how inflation and a lack of public confidence in assignats led to the demise (b) Comment on the evolution of the nominal and the real values of assignats in the years 1795 and 1796. (You may use all three figures for this question). In 1795 and 1796 the nominal value of assignats (Figure 1) continued to rise steeply especially in 1796 In Figure 2 the real value drops quickly during this period reaching near 0 levels Figure 3 shows negative inflation and decreasing balances as the assignats lost their role as a credit store of value → so, excessive issuance of assignats became unsustainable so they became worthless (c) Comparing the two periods of the Terror and the one after (95 and 96), in which of these two period, do think that more revenues were generates by creating new assignats? Justify your answer. (Your argument is more important than your guess of the period).  More revenues were likely generated during the Terror period than in the post Terror period 95 and 96 because during the Terror the issuance of assignats significantly increased (figure 1) and despite a decline in real value (figure 2) the currency still had some purchasing power allowing the government to extract some revenues By 1795 and 96 the real value of assignats had collapsed (figure 2) and inflation likely discouraged their use (figure 3). Creating new assignats would have generated minimal revenue since the market had already lost confidence in their value Glorious Revolution - slides 12 part 2 Political and religious concerns - birth of James II’s son b/c it would change line of succession from Protestant to Catholic ○ The internal cause was the growing dislike with James II’s monarchy and his ambition to promote Catholicism and therefore a Catholic dynasty ○ The external cause was the political climate in Europe, especially fears of Catholic alliance and the influence of France under Louis XIV. The desire for a Protestant succession to continue through England was found in William of Orange who was Protestant and his wife Mary who was James II’s Protestant daughter. protestant Whigs and Tories grew concerned about James II’s policies and his attempts to promote Catholicisim With the emergence of the Whigs and their newfound political power James II responded in the overseas element of taxation and increasing his revenue. The factions and the general English population were fearful of James II’s political power, disregard for Parliament, and religious beliefs. Ultimately, this prompted the invitation William of Orange to invade England, leading to James's flee and the establishment of the new monarchy. did not change the security of property rights; many Protestants and the political factions of the Whigs and Tories were motivated by concerns that James II’s policies threatened their economic interests and property. The defense of property rights was crucial to the broader political landscape of the time. They argue that the Glorious Revolution was not merely a religious conflict but also a reaction to James II's attempts to centralize power and undermine traditional rights associated with property ownership. Tories and Whigs - slides 12 part 1 The Whigs were the primary drivers of the “revolution” and more likely to support parliamentary rule and were critical of James II’s monarchy advocating for Protestant leadership and protecting civil liberties The Tories generally supported the monarchy and were more willing to accept James II's rule, believing in a more traditional hierarchical structure. Tories were initially hesitant about a change in government and they generally favored maintaining the monarchy and hoped for reforms within the existing structure rather than a complete overthrow, the Tories wanted a short and cheap war Financial institutions against the taxpayers Annuities : a bond you pay a lump sum upfront, and in return you receive payments overtime (lifetime annuities) or for a specific number of years England government would sell annuities to raise funds for war Payments were funded by tax revenues so would use taxpayer money to pay back Also helped avoid raising taxes Redeemable vs non redeemable annuities Redeemable → can be redeemed at par after a specified date, and their value is sensitive to interest rate changes—lower interest rates make them more attractive. Non redeemable → don’t have a redemption option and pay a fixed annual cash flow until maturity. The price of non-redeemable annuities doesn’t fluctuate as much with interest rates, If the price of the 3% non-redeemable annuity is 75, the long term interest rate is 4%. The present value is 75, the annual cash flow is 3 because if we assume the face value of the annuity is 100 we determine 3% of 100. By dividing 3 by 75 we are able to find the interest rate. French Revolution Goods were taxed indirectly → heavy taxes on the third estate (common people) and less on the high classes Debt especially from war Called Estates General to avoid default and increase taxation China vs Europe Europe ○ fragmentation ○ Small state size ○ High exit ability ○ Warfare ○ More likely political representation (parliaments) ○ Favors elites ○ External threats (ex England vs France) China → low taxation ○ centralization ○ Large state size ○ Low exit ability ○ Warfare ○ Less likely parliaments b/c of geographical scale ○ Favors rulers  ○ Internal threats (rebellions and civil wars) Medieval university and commercial growth in Germany Churches originally restricted universities ○ Papal Schism → division in church Many people who attended universities in France were wealthy but after the Schism anyone was attending → reduction of travel cost More markets were created in towns closer to new universities (market grants) Universities provided students with legal training → led to development of legal and administrative institutions, which was an important channel linking universities and greater economic activity in medieval Germany The printing press → expanding economic activity in Europe Invented by Gutenberg Printing press had a positive impact on city growth BUT being closer to Mainz (where Gutenberg invented the printing press) didn’t automatically mean a city grew faster it’s unclear whether the proximity to Mainz directly caused faster growth or if other factors were at play Persistence - assignment 7 cultural traits—particularly those rooted in historical events and experiences—have a significant, long-lasting impact on economic outcomes and institutional development, even centuries after the original events Modern theory of public finance → fiscal policy to stabilize economic Normal levels during peacetime, Dramatic decline shows significant deficit of budget during wartime – increase in spending and borrowing, budget reforms taxation or debt repayments increase levels back to normal