L6 Putting Is-mp To Work

Question 1

If we had the Taylor Rule for our MP curve, what would a rise in G do for the overall income? Ie is the multiplier fully felt?

Answer 1

No! 
Higher G shifts IS, Y rises
BUT change in Y is less than
 •G/(1-c)
Because the monetary authority ain’t so keen on expansion

Question 2

A more accommodative monetary regime (lower m.y) implies…

Answer 2

A higher fiscal multiplier.

So the implications of this are that the effects of fiscal policy are conditioned by the monetary response to it

Question 3

What’s the classical argument to crowing out?

Answer 3

Private savings are fixed. If the government borrows more, there are fewer savings to be invested

This is IRRESPECTIVE of CB behavior

Question 4

What’s the Keynesian story to ‘crowing out’?

Answer 4

End result in IS-MP similar,
Higher G means higher Y which raising R which contracts I

There’s nothing inevitable from reduced investment; follows from CB actions

Question 5

If we have a ZLB, what’s the equation for the real rate that the CB can choose?

Answer 5

R= max { Taylor rule , r_LB }

Question 6

What’s the size of the multiplier when we get a liquidity trap? (5)

Answer 6

It’s large!

Question 7

What could reduce a change in r bar, our ‘natural rate’? Think of long-run changes and the first of S and I(r)

Answer 7

• secular decline in investment opportunities, I(r) shifting onwards
• decline in LR gvt spending
• ageing population would mean saving more for retirement, reduction in Č (if had linear version)

The two last points would DRIVE UP saving

Question 8

What would a reduction in our natural rate r do to IS and LM?

Answer 8

Would shift IS down (a fall in r is brought about as a result of a fall in autonomous consumption and investment, which are the intercept components of the IS curve)

Would also shift the MP curve down by an equal amount with no presence of the ZLB

The result would be (6). Think what would happen to equilibrium income if BOTH SHIFT BY SAME AMOUNT

Question 9

What’s the main idea behind the secular stagnation hypothesis?

What are the implications of monetary policy? Think r_LB = negative inflation expectations

Answer 9

That the natural rate is falling too low, which undermines the ability to ensure that Y=Ŷ even in absence of IS shocks.

Maybe we should raise inflation expectations so as to lower the lower bound

Question 10

What’s passive fiscal policy all about? What does it mainly relate to?

Answer 10

It’s talking about automatic stabilisers, which are automatic changes in fiscal instruments over the business cycle

T! Because we have:

1. Lower income tax receipts during recessions than booms
2. Transfer payments in form of unemployment benefits etc