David K.H. Begg, Gianluigi Vernasca-Economics-McGraw Hill Higher Education (2011)

Review questions
IS-LM diagram, recognizing that Greece is a eurozone member. (b) Suppose Greece left the
eurozone; what, if anything, would be different?
1 0 Imagine a world of only two periods and zero interest rates. A consumer's income is 100 in each
period, taxes are 50 each period, permanent disposable income is therefore 50, and consumption
is 50 per period (since the world ends after period 2). The government now offers a tax cut of 10 in
period l, financed by government borrowing that will be repaid in period 2. (a) Since interest rates
are zero, by how much must the government raise taxes in period 2 in order to pay off its loan in
full? (b) What is disposable income now in each period for the consumer? (c) Since interest rate is
zero, what is permanent disposable income? (d) What is the effect on consumption decisions?
( e) If the government pays zero interest on loans, but the consumer pays l 0 per cent interest, how is
permanent income affected? (f) What now is the effect of the temporary tax cut?
11 Suppose mortgage lenders issued 20-year loans at fixed interest rates. (a) How would short-term
changes in interest rates impact households with a mortgage? (b) Would the Bank of England have
to change interest rates by more or by less to have the same effect on aggregate demand as at
present?
1 2 Suppose monetary policy raises nominal interest rates by 0.8 every time inflation rises by 1.
(a) How do you expect the central bank to manage stabilizing inflation around a low level? (b) Suppose
inflation is nevertheless low and stable: how might you explain this outcome?
1 3 Essay question 'If households can lend and borrow easily, their consumption and saving decisions
simply offset anticipated future tax changes. The principal power of taxation policy to influence
aggregate demand arises because households in practice face difficulties borrowing what would be
required to implement Ricardian equivalence: Discuss.
For solutions to these questions contact your lecturer.
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