Macroeconomic Research

Global Economic Environment III – Problem Set 8

Name: Ankur Dubey | MBA Class: 2017 | UNI: ad3255

Ch 23

3.        Reactions by the policy makers for the following shocks:

(a)        Consumers reduce autonomous consumption: This will cause the AD curve to shift left, to facilitate the equilibrium to long-term equilibrium point, the policy makers will pursue expansionary monetary policy by lowering the interest rates, so that the AS curve shifts to the right.

(b)        Financial frictions decrease: This will not impact either the demand or supply, therefore no response from policy makers

(c)        Government spending increases: This will cause the AD curve to shift to the right, to facilitate the equilibrium to long-term equilibrium point, the policy makers will pursue tighter monetary policies by increasing the interest rates so that the AS curve shift to the left.

(d)        Taxes increase: AD curve will shift left given decreased disposable income and therefore decreased consumer demand. Policy makers will have to pursue expansionary monetary policy for AS curve to shift to right.

(e)        The domestic currency appreciates: Appreciated domestic currency will facilitate imports by the country, which will result in increased consumer demand leading to AD curve shifting to the right. Policy makers will have to pursue tightening of monetary policy such that the AS curve shifts to left.

8.        Country A: Monetary tightening

        Country B: Monetary easing

        Country C: Most likely fiscal policy change and no monetary policy change

18.        Uncertain: The decrease in data and recognition lag will not necessarily be good for the economy. In certain cases, it may result in quicker and thus overreaction by policy makers to any shocks that could be self-corrected in time.

20.        In such an event, the policy makers will set their benchmarks for natural unemployment rate at 7%. Therefore, in the event the unemployment rate approaches 7% from higher figures they will start pursuing tightening of monetary policy which will result in economy never reaching its actual natural unemployment rate and therefore never reaching its long-run output levels (Yp).

23.        The key element of self-correcting mechanism is autonomous shifts in the AD curve. However, when the rates fall to zero, there is no further scope for AD curve shifting. Given this constraint the self-correcting mechanism does not work in such scenarios.

24.        Quantitative easing: Using this policy, the central bank increases liquidity in the market by buying long term bonds of banks. This is funded by either printing more money or creating notional money in the electronic books. Such funds are then made available to the market which causes inflation to increase.

27.        Lower slope (flatter) of demand curve results in much lesser increase in inflation in the event of reverting to equilibrium after a supply shock. As illustrated below, in the event of a temporary supply shock (i.e. AS curve shifting left), the inflation for the flatter AD curve (π2) is lesser than the inflation for steeper AD curve (π3)