C = 100 + 0.5 · (Y – T) I= 500 – 1000 - r where Y is real output and r is the real interest rate. Government purchases and taxes are G = 500, Ť = 100. The LM (money market equilibrium) curve is M_Y where P is the price level and i is the nominal interest rate. The Central Bank (CB) is initially supplying M = 8000 units of money, and expected inflation is aª = 0. Assume that the long-run equilibrium level of output is Y = 2000. Short-run equilibrium output is initially at the same level (Y = 2000). Suddenly, news of a new world-beating super-vaccine raises expected inflation to = 0.05. 1. Suppose the government (not the CB) wants to stabilise the shock in the short-run. Explain whether it should increase the government deficit (AĞ > AŤ) or reduce it (AĞ < AT), and how it works. 2. Now suppose the government doesn't do anything, and the CB wants to stabilise the shock in the short-run. Explain whether it should decrease or increase money supply M if it wants to bring output Y back to its long-run equilibrium level. What would happen to the nominal and real interest rate in the short-run, if the CB follows this policy?

C = 100 + 0.5 · (Y – T) I= 500 – 1000 - r where Y is real output and r is the real interest rate. Government purchases and taxes are G = 500, Ť = 100. The LM (money market equilibrium) curve is M_Y where P is the price level and i is the nominal interest rate. The Central Bank (CB) is initially supplying M = 8000 units of money, and expected inflation is aª = 0. Assume that the long-run equilibrium level of output is Y = 2000. Short-run equilibrium output is initially at the same level (Y = 2000). Suddenly, news of a new world-beating super-vaccine raises expected inflation to = 0.05. 1. Suppose the government (not the CB) wants to stabilise the shock in the short-run. Explain whether it should increase the government deficit (AĞ > AŤ) or reduce it (AĞ < AT), and how it works. 2. Now suppose the government doesn't do anything, and the CB wants to stabilise the shock in the short-run. Explain whether it should decrease or increase money supply M if it wants to bring output Y back to its long-run equilibrium level. What would happen to the nominal and real interest rate in the short-run, if the CB follows this policy?

Essentials of Economics (MindTap Course List)

8th Edition

ISBN:9781337091992

Author:N. Gregory Mankiw

Publisher:N. Gregory Mankiw

Chapter24: The Influence Of Monetary And Fiscal Policy On Aggregate Demand

Section: Chapter Questions

Problem 5CQQ

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