1.IS Curve: IS Curve with numbers. Suppose that the parameters of the IS curve are a¯ = 0, ¯b = 3 4 , ¯r = 2%, and the Federal Funds rate is originally Rt = 2%. Explain what happens to short run output under each of the following scenarios:
(a) The Federal Funds rate rises to 5%.
(b) The Federal Funds rate falls to 0%.
(c) ac decreases by 2 percentage points.
(d) aim increases by 1 percentage point.
2.IS and Phillips Curve: Today, the CBO estimates that actual output is 1% above potential output. Nevertheless, President Trump has put pressure on the Federal Reserve Chairman Jerome Powell to continue decreasing the Federal Funds rate. Explain how lowering the Federal Funds rate would impact short-run output. According to the Phillips Curve, what would this do to the inflation rate?
3.IS Curve Ricardian Equivalence: Assuming Ricardian equivalence holds, describe the impact of each of the following changes in government policy on output.
(a) A version of the “Green New Deal” is passed into law and signed by President Elizabeth Warren. Assume that this law will temporarily increase government spending by $100 billion per year for 5 years in order to insulate buildings, install solar panels, etc.
(b) President Trump signs a bill that reduces taxes, but does not cut government spending. Consumers expect this to be a permanent tax cut.
(c) President Trump signs a bill that reduces taxes, but does not cut government spending. Consumers expect this to be a temporary tax cut that will be reversed the next time a Democrat wins the presidency.
4. IS-MP:
(a) Set up the IS-MP diagram, making sure to label everything clearly. Label the initial equilibrium as “A.”
(b) Suppose there is a positive demand shock. Illustrate any changes using the diagram you set-up in part (a), and label the new equilibrium as “B”.
Suppose the government can perfectly observe the size of the shock, and they decide to take action to restore short-run output to Y˜ t = 0.
(c) Illustrate how the diagram would change if the government chose to respond using monetary policy. Label this equilibrium as “C”.
(d) Illustrate how the diagram would change if the government instead chose to respond using fiscal policy. Label this equilibrium as “D”.
5. Phillips Curve: Recall the Phillips Curve
πt = πt−1 + vY˜ t + σ
Suppose that in 2017 the inflation rate was 2%. Suppose that σ = 0 and v = 0.5. Using the short-run output numbers you calculated in number 1 at the beginning of this homework, find the inflation rate in each of the following years: 2018, 2019, 2020, 2021, 2022, and 2023.
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