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Fiscal consolidation revisited.

Fiscal consolidation revisited.

ENGR.ECONOMIC ANALYSIS
ENGR.ECONOMIC ANALYSIS
14th Edition
ISBN:9780190931919
Author:NEWNAN
Publisher:NEWNAN
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
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Please ONLY answer questions V and onwards 

2. Fiscal consolidation revisited. Suppose inflation at time t is given by n; = r°; + m+2 - au, and inflationary expectations are given by n, = 0 T1+ (1-0) 1, where os es1, and nis a constant. For what values of 8 do we obtain the original Phillips curve relation? For what values of 8 do we obtain the new Phillips curve relation? i. il. Suppose the economy is initially at a medium-run equilibrium (defined by Y, un, and ra). Consider the case where the government decides to reduce government expenditure (G) to decrease the deficit (holding taxes constant). Additionally, suppose the value of eis consistent with the original Phillips curve relation. iii. Demonstrate the effect of a reduction in government expenditure on the IS curve and the PC in the short run. iv. If the central bank only cares about the level of inflation, how should it respond to the fiscal consolidation? What happens to unemployment? Macroeconomics Problem Set #2 v. If the central bank only cares about the inflation growth rate, how should it respond to the fiscal consolidation? vi. If the central bank only cares about the level of output, how should it respond to the fiscal consolidation? What happens to unemployment? vii. Suppose the central bank adjusts the real interest rate to return the economy to a medium-run equilibrium consistent with a zero out put gap. How does the level of inflation compare to its level before the fiscal consolidation? Now suppose the value of 0 is consistent with the new Phillips curve relation. vii. Demonstrate the effect of a reduction in government expenditure on the IS curve and the PC in the short run. ix. Suppose the central bank adjusts the real interest rate to return the economy to a medium-run equilibrium consistent with a zero out put gap. How does the level of inflation compare to its level before the fiscal consolidation? What will occur if the real interest rate corresponding to the zero lower bound is greater than the new natural rate of interest, r.? Ilustrate this situation using the IS-LM-PC model.
Transcribed Image Text:2. Fiscal consolidation revisited. Suppose inflation at time t is given by n; = r°; + m+2 - au, and inflationary expectations are given by n, = 0 T1+ (1-0) 1, where os es1, and nis a constant. For what values of 8 do we obtain the original Phillips curve relation? For what values of 8 do we obtain the new Phillips curve relation? i. il. Suppose the economy is initially at a medium-run equilibrium (defined by Y, un, and ra). Consider the case where the government decides to reduce government expenditure (G) to decrease the deficit (holding taxes constant). Additionally, suppose the value of eis consistent with the original Phillips curve relation. iii. Demonstrate the effect of a reduction in government expenditure on the IS curve and the PC in the short run. iv. If the central bank only cares about the level of inflation, how should it respond to the fiscal consolidation? What happens to unemployment? Macroeconomics Problem Set #2 v. If the central bank only cares about the inflation growth rate, how should it respond to the fiscal consolidation? vi. If the central bank only cares about the level of output, how should it respond to the fiscal consolidation? What happens to unemployment? vii. Suppose the central bank adjusts the real interest rate to return the economy to a medium-run equilibrium consistent with a zero out put gap. How does the level of inflation compare to its level before the fiscal consolidation? Now suppose the value of 0 is consistent with the new Phillips curve relation. vii. Demonstrate the effect of a reduction in government expenditure on the IS curve and the PC in the short run. ix. Suppose the central bank adjusts the real interest rate to return the economy to a medium-run equilibrium consistent with a zero out put gap. How does the level of inflation compare to its level before the fiscal consolidation? What will occur if the real interest rate corresponding to the zero lower bound is greater than the new natural rate of interest, r.? Ilustrate this situation using the IS-LM-PC model.
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