Lesson 8

Question 1

Temporary Change in Monetary and Fiscal Policy

Answer 1

in the SR output is variable but Governments can use stabilization policies to offset the impact of the demand shocks

Question 2

Limit to Monetary Policy

Answer 2

Zero lower bound (interest rates can only go to zero) which implies that E can only go so high

Emax=Ee/(1-R*) where R = 0 [Liquidity Trap]

Question 3

Permanent Changes in Monetary Policy

Answer 3

Different SR and LR effects than of a temporary policy change

Question 4

Features of LR Equilibrium

Answer 4

Y=Yf
E=Ee
R=R*
P if flexible and adjusts so that Ms/P = Md/P
E adjusts so that AD = Yf

Question 5

Permanent Changes in Monetary Policy

Answer 5

Leads to change in LR exchange rate

Question 6

Changes in Monetary Policy

Answer 6

Temp - Ee does not change

Permanent - Ee changes in SR and matches E in LR

Question 7

Short Run Effects

Answer 7

P-fixed
Ee instantly increases, shifts the AA up
Since P is fixed in SR Ms increase means a decrease in R
Now R

Question 8

Long Run Effects

Answer 8

Yf

Question 9

Pass through = 1

Answer 9

Nominal = Real

Question 10

Pass through < 1

[Incomplete]

Answer 10

Nominal > Real

Question 11

Import Prices

Answer 11

E x P*

Question 12

Permanent increase in Ms

Answer 12

Larger SR increase in Y due to an additional rightward shift of AA

Question 13

When the real exchange rate (q =E∙P*/P) rises the prices of foreign products rise relative to the prices of domestic products, giving rise to the following three effects

Answer 13

Exports bought rises (Ex up)
Imports bought falls (Im down)
Value of imports rises (P* more expensive) (Im up)

Question 14

Marshall-Lerner condition

Answer 14

the volume effects outweigh the value effect is a valid one if export and import volumes are sufficiently price elastic with respect to a change in the real exchange rate [confirmed by empirical evidence]

Question 15

The J Curve

Answer 15

after a nominal and real depreciation the current account balance (CA) first decreases as the value of imports rises, and then gradually increases as the volume effects begins to dominate the value effect

Question 16

We found that temporary changes in monetary and fiscal policies could be used to stabilize the levels of demand and output at their full-employment level, by offsetting the impact of demand shocks.

Answer 16

We found that temporary changes in monetary and fiscal policies could be used to stabilize the levels of demand and output at their full-employment level, by offsetting the impact of demand shocks.

Question 17

A permanent increase in money supply was found to have a more expansionary short-run impact on output than the same-sized temporary change in money supply. However, in the long-run a permanent increase in money supply has no effect on output and results in increases in the price level and nominal exchange rate which are proportionate to the increase in money supply.

Answer 17

We then analysed the effects of a permanent increase in government purchases and found that it had no short-run or long-run impact on the level of output.

Question 18

Incomplete pass-through reduces the impact of a nominal depreciation on the current account balance

Answer 18

True

Question 19

Under flexible exchange rates, a temporary increase in domestic money supply will

Answer 19

shift the AA curve up or to the right with no shift in the DD curve and increase both equilibrium output (Y) and the equilibrium exchange rate (E)

Question 20

Under flexible exchange rates, a temporary increase in government purchases increases the level of output which leads to an increase in the interest rate, and a decrease in the exchange rate.

Answer 20

True

Question 21

Under flexible exchange rates, a permanent increase in the money supply will cause a____________ SHORT-RUN increase in equilibrium output (Y) than would a purely temporary increase in money supply (of the same size) because, compared to the purely temporary increase, the permanent increase in money supply causes a______________

Answer 21

larger; larger rightward shift of the AA curve as the expected exchange rate rises

Question 22

AA-DD Model

Answer 22

AA - downward sloping

DD - upward sloping

Question 23

Assume an economy initially in long-run equilibrium at full employment operating with flexible exchange rates. The government implements a permanent increase in government purchases. Assuming that the expected exchange rate adjusts instantly to its new long-run equilibrium level, we can predict that this permanent increase in G will

Answer 23

shift the DD curve to the right 
shift the AA curve down or to the left 
Results
equilibrium output (Y) unchanged 
decreasing the equilibrium exchange rate (E)