Reference no: EM133339898

Why would stocks fall on solid economic data? Let's explore this apparent puzzle.

a. Think about the goods & services market, and the AD-AS model discussed in class. Assuming the news on solid economic data reflects a shift of the AD curve, in which direction (positive vs. negative shock) would it shift? What would be the effects on output and inflation? Which of these are stock markets worried about?

b. How would the news on solid economic data affect expectations regarding the central bank's future moves? In particular, think in which of the three markets discussed in class-the domestic goods & services market, the domestic market for money, or the foreign exchange market-the central bank is expected act, and be sure to explicitly refer to the price in that market and to what the central bank's activity is expected to do to that price.

c. In order for the central bank to affect the price you indicated in (b) in the direction you indicated, what would the bank sell? What would it buy? What price in what other market is it ultimately trying to affect?

d. Now let's think about the foreign exchange market. For simplicity, imagine a situation where the solid economic data from the US were the only news on that day (that is, no other news arrived about the rest of the world). In light of your answers in (b) and (c) above, what would you expect in that imaginary situation would happen to the exchange rate of the dollar, and why? Explain.

e. A recent article in The Economist (November 26, 2022, "The US economy: Hot like Minnesota") states about Minnesota:

"Its unemployment rate has started to tick up, rising from 1.8% in June to 2.1% last month. It might seem perverse to call that good news, but one lesson from the past year is that excessively low unemployment really does hurt: it constrains and corrodes the services offered by hospitals, schools, restaurants and more." This "good news" from Minnesota is very different from the "solid economic data" in the WSJ.com article at the beginning of this question. If the trend from Minnesota spreads to the rest the US economy, how is it likely to change expectations regarding the following indicators of the US economy: [i] inflationary pressures; [ii] interest rates (as a result of [i]); (iii) the US dollar (as a result of [ii])? For each, be sure to state whether you would expect it to go up or down.