Q8. Using your answers to questions 2 and 7 find out when fiscal policy is more
ID: 1124590 • Letter: Q
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Q8. Using your answers to questions 2 and 7 find out when fiscal policy is more effective- under fired interest rate (Keynesian cross) or in the IS-LM model, where interest rate can vary? In which case do you think the fiscal multiplier is higher? Problem 3.(10 points) Suppose the short run Phillips curve has a form: .--1 (ut-u"), where u. is the natural rate of unemployment, is expected inflation. Inflation expectations are nave: t-1. In period 0, uo = 0.04, and inflation expectations equal actual inflation. 1. Determine the NAIRU. 2. Cold-turkey. Suppose in period 0, = -0.12, and in period l the CB runs contractionary policy that decreases inflation to 0.02. For periods 1 through 4, determine the rate of cyclical unemployment and the percentage deviation of GDP from its potential level, if the Okun's coefficient equals 2. Compute the overall sacrifice ratio and illustrate on a graph Problem 4.(20 points) Use AD-AS model to analyze how the following shocks will affect economic activity in short and long run: 1) illustrate changes that wl occur using AD-AS graph; 2) provide explanation for why each curve shifts 1. The government raises the amount it spends on pension benefits 2. An earthquake destroys several factories 3. The government reduces expenditure on national defense . A country the US trades with increases prices on their key productsExplanation / Answer
ANS 8=
If government employs an expansionary fiscal policy strategy (when interest rates can vary)& raises its spending to stimulate economic activity. This causes a rise in ROI. Increased ROI impacts corporate investment decisions. A high degree of the ‘crowding out impact’ may even lead to lower income levels in the economy.
With higher ROI, the cost for funds to be invested rises & impacts their availability to debt financing systems. This causes lower investment finally & crowds out the effect of the initial increase in the overall investment spending. Normally the initial rise in government spending is funded utilizing higher taxation/ governmental borrowing .
Hence, we can say that under Keynesian Cross the fiscal multiplier is higher .
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