1. Evaluate the following statement using the models studied in class: "A fiscal expansion will always reduce investment in an economy". Is this statement true or false, and why? 2. If the government wants to reduce the budget deficit, how can the central bank keep the economy from going into a recession? Use the closed economy IS-LM model to illustrate graphically the impact of both the fiscal policy reducing the deficit and the monetary policy, which prevents output from falling. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium values; iv. the direction the curves shift; and v. the terminal equilibrium values. 4. Consider the inflation and unemployment data in the table below for the United States between 1990 and 2005. Assuming Okun's Law holds true (i.e. 1% of unemployment is approximately equal to 2% of lost output), using the data above, calculate the sacrifice ratio for the US economy. Based on your answer, can you say anything about whether people in the economy form expectations based on rational expectations or adaptive expectations? Natural Rate Unemployment Unemployment Year U Un Inflation 1990 5.6 6.1 5.4 1991 6.9 6.4 4.2 1992 7.5 6.5 3.0 1993 6.9 6.4 3.0 1994 6.1 6.2 2.6 1995 5.6 5.8 2.8 1996 5.4 5.4 3.0 1997 4.9 5.0 2.3 1998 4.5 4.8 1.6 1999 4.2 4.6 2.2 2000 4.0 4.6 3.4 2001 4.7 4.8 2.8 2002 5.8 4.9 1.6 2003 6.0 5.0 2.3 2004 5.5 5.1 2.7 2005 5.1 57 3.4