[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

3. Assume that the economy is currently at full employment
with an inflation rate of 2 percent. The government
embarks on a major new expenditure program
that increases aggregate expenditures (assume that
full-employment output is unaffected).
(a) If the central bank’s policy rule remains unchanged,
what will be the short-run and long-run effects on
output and inflation of this change in fiscal policy?
What will be the long-run effects on the real interest
rate at full employment?
(b) Suppose the central bank’s policy rule adjusts to
reflect the change in the full-employment real interest
rate. Will this alter the short-run or long-run
effects of the fiscal expansion?
4. In late 2000, there were signs the U.S. economy might be
heading into a recession. Some argued that the rise in
energy prices during 2000 was the cause of the economic
slowdown. Others pointed to the decline in the
stock market and argued that this decline in wealth
would reduce consumption spending. Assume the
economy is initially at full employment.
(a) Using the ADI-IA (inflation adjustment) framework,
explain how a rise in energy prices would affect
output and inflation in the short run.
(b) Using the ADI-IA framework, explain how a fall in
stock prices would affect output and inflation in the
short run.
(c) Suppose you are chair of the Federal Reserve
Board. If your only concern is keeping inflation
stable, would you raise interest rates or would you
lower them if you believe energy prices are the
cause of the slowdown? Would you raise interest
rates or would you lower them if you believe the
stock market decline is the cause of the slowdown?
(d) Suppose you are chair of the Federal Reserve
Board. If your only concern is keeping unemployment
stable, would you raise interest rates or would
you lower them if you believe energy prices are the
cause of the slowdown? Would you raise interest
rates or would you lower them if you believe the
stock market decline is the cause of the slowdown?
5. Suppose a fall in net exports due to a recession among
our major trading partners causes a recession in the
United States.
(a) If fiscal policy is used to stimulate the economy
and return it to full employment, what happens
to the real interest rate, investment, and future
output?
(b) If monetary policy is used to stimulate the economy
and return it to full employment, what happens
to the real interest rate, investment, and future
output?
6. In parliamentary governments, such as the United
Kingdom, the prime minister can announce a change in
taxation or expenditure and implement that change
almost immediately. How might this fact affect the balance
between the use of monetary and fiscal policy for
short-run stabilization?
REVIEW AND PRACTICE ∂ 753