the sensitivity of the slope of the AD curve to assumptions about how fiscal policy is...
Fantastic news! We've Found the answer you've been seeking!
Question:
Transcribed Image Text:
the sensitivity of the slope of the AD curve to assumptions about how fiscal policy is determined (which would affect goods market equilibrium) as well as how the financial markets might react to such government behaviour (which would affect the interest rate term). Going forward, when studying the interaction between aggregate demand and the short-run aggregate supply slope plays an important role. Start with goods market equilibrium (GME), which is given by:¹ - (2) Y G y-y=a (g-g) - a₂ (r-r), where a₁ = m * (*): Y a₂ = -m (1) The variables with bars represent long-run values, while m is the Keynesian multiplier and is defined as: 1 Note that the variable v, a measure of consumer confidence, is excluded to keep the algebra simple. 1 1-(1-T)Cy - Iy The real risky interest rate (r) is defined as: m = r=r + p ->1 Note that: (2) where r' is the risk-free real interest rate and p is a measure of risk. The long-run equilibrium values of the variables in (2) are given by: T=F¹ + P (3) The central bank is assumed to follow a standard Taylor rule when setting it nominal policy interest (i): i² = ¹ +²₁₁ +h(л−л*)+b(y-ỹ), h>0, b>0 (4) (5) The variables is the central bank's target rate of inflation, while i' is the nominal policy rate, which the central bank can control in the short run. Finally, counter-cyclical fiscal policy is introduced into the mix. In particular, suppose that the fiscal-policy reaction function takes the following form: g-g=-y(y-y) (6) a) Start by subbing equation (6) into the GME. Comparing the slope of the curve with the case where y = 0, which one is steeper and why? Now use equation (5) to eliminate i" from (4) and then derive an equation for r- as it relates to the Taylor rule and the risk premium, p-p. Finally sub that equation into the GME to get the AD curve, written with л-л on the left hand side. b) Compare the slope of the AD curve you derived in part a, with that in the text (equation (34), Chapter 16). If these slopes are different explain why. In analyzing the difference between AD curves, you are to refer to the figure in slide 16 in the lecture slides to Chapter 16 Part 2 and to use the equations you derived for GME and the TR. c) As often as not, fiscal policy is pro-cyclical, implying that the fiscal reaction function is: g-g=y(y-y) (6') In this case, what happens to the slope of the AD curve? Using the two-diagram framework referred to above, does this fact imply that the central bank has to raise interest rates more or less in response to an increase in actual and/or expected inflation? d) Financial markets also react to policy developments. Here we assume that the financial markets act as "fiscal vigilantes", driving up private-sector interest rates by raising the risk premium when fiscal policy is pro-cyclical and vice versa: p-p=0(g-g) Incorporate (7) into your part c model and derive a new AD curve. Compare the slope of this AD curve with the one you found in part c. Again, which is steeper and why? (7) the sensitivity of the slope of the AD curve to assumptions about how fiscal policy is determined (which would affect goods market equilibrium) as well as how the financial markets might react to such government behaviour (which would affect the interest rate term). Going forward, when studying the interaction between aggregate demand and the short-run aggregate supply slope plays an important role. Start with goods market equilibrium (GME), which is given by:¹ - (2) Y G y-y=a (g-g) - a₂ (r-r), where a₁ = m * (*): Y a₂ = -m (1) The variables with bars represent long-run values, while m is the Keynesian multiplier and is defined as: 1 Note that the variable v, a measure of consumer confidence, is excluded to keep the algebra simple. 1 1-(1-T)Cy - Iy The real risky interest rate (r) is defined as: m = r=r + p ->1 Note that: (2) where r' is the risk-free real interest rate and p is a measure of risk. The long-run equilibrium values of the variables in (2) are given by: T=F¹ + P (3) The central bank is assumed to follow a standard Taylor rule when setting it nominal policy interest (i): i² = ¹ +²₁₁ +h(л−л*)+b(y-ỹ), h>0, b>0 (4) (5) The variables is the central bank's target rate of inflation, while i' is the nominal policy rate, which the central bank can control in the short run. Finally, counter-cyclical fiscal policy is introduced into the mix. In particular, suppose that the fiscal-policy reaction function takes the following form: g-g=-y(y-y) (6) a) Start by subbing equation (6) into the GME. Comparing the slope of the curve with the case where y = 0, which one is steeper and why? Now use equation (5) to eliminate i" from (4) and then derive an equation for r- as it relates to the Taylor rule and the risk premium, p-p. Finally sub that equation into the GME to get the AD curve, written with л-л on the left hand side. b) Compare the slope of the AD curve you derived in part a, with that in the text (equation (34), Chapter 16). If these slopes are different explain why. In analyzing the difference between AD curves, you are to refer to the figure in slide 16 in the lecture slides to Chapter 16 Part 2 and to use the equations you derived for GME and the TR. c) As often as not, fiscal policy is pro-cyclical, implying that the fiscal reaction function is: g-g=y(y-y) (6') In this case, what happens to the slope of the AD curve? Using the two-diagram framework referred to above, does this fact imply that the central bank has to raise interest rates more or less in response to an increase in actual and/or expected inflation? d) Financial markets also react to policy developments. Here we assume that the financial markets act as "fiscal vigilantes", driving up private-sector interest rates by raising the risk premium when fiscal policy is pro-cyclical and vice versa: p-p=0(g-g) Incorporate (7) into your part c model and derive a new AD curve. Compare the slope of this AD curve with the one you found in part c. Again, which is steeper and why? (7)
Expert Answer:
Related Book For
Probability and Statistics
ISBN: 978-0321500465
4th edition
Authors: Morris H. DeGroot, Mark J. Schervish
Posted Date:
Students also viewed these economics questions
-
In this exercise you will prove Theorem 9.8.2. a. Prove that the joint p.d.f. of the data given the parameters 1, 2, and can be written as a constant times b. Multiply the prior p.d.f. times the...
-
In Freezone, shown in Figure 30.4, the aggregate demand curve is AD, potential GDP is $300 billion, and the short-run aggregate supply curve is &4SB. In Figure 30.4, a. What are the price level and...
-
In this exercise, you will define language four, an extension of language three. Here is a sample program in language four, showing all the new constructs: let val fact = fn x => if x<2 then x...
-
In Exercises find the vertex, focus, and directrix of the parabola, and sketch its graph. x 2 + = 0
-
The Virginia Cooperative Extension reports that the mean weight of yearling Angus steers is 1152 pounds. Suppose that weights of all such animals can be described by a Normal model with a standard...
-
Identify the accounts in which each of the following transactions for Acorn Furniture, a custom manufacturer of oak tables and chairs, would be debited and credited: 1. Issued oak materials into...
-
Sumitomo Cable manufactures various types of aluminum and copper cables which it sells directly to retail outlets through its distribution channels. The manufacturing process for producing cables...
-
On January 1, Vince Corporation purchased a 25% equity in Morelli Corporation for $180,000. At December 31, Morelli declared and paid a $60,000 cash dividend and reported net income of $200,000....
-
On the 1 January 2023, Garak's Goods Ltd sold some plant to Kleen Ltd for $82,000. Garak's Goods Ltd had originally paid $120,000 for this asset, and by the time of sale had charged accumulated...
-
Sgt. Barnes is a veteran police officer filing as Head of Household. Currently, her taxable income is $50,000, but has been asked to sit for the Leutenant's exam. She is excited about the opportunity...
-
You are assigned to replace the existing project manager in charge of the Sandora product line. You understand there are issues with outsourcing manufacturing to overseas suppliers, which have been...
-
Below is an alphabetical list of Terrier Company's December 31, 2022 balance sheet accounts and amounts. Prepare a properly formatted, classified balance sheet for Terrier Company. You may prepare...
-
In what ways is social stratification both constructed and perpetuated, while concurrently manifesting through mechanisms of privilege and/or oppression in the lived experiences of individuals within...
-
Describe how quantitative and qualitative data are treated differently in analysis. What kind of questions are qualitative and quantitative data well suited to address? Explain, with examples.
-
Consider the following circuit CLK QA CLK O 1 K J 9 Q 16 K 15 QB 30 J Q CLK K k " o QD 1. Give the equations for the inputs J, K of the flip flops 2. We suppose that the initial value of the...
-
What is an economic argument in favor of more humane border policies regarding migrants and refugees?
-
C can react with CO 2 to form CO . If this reaction is applied with low processing cost, explain its impact on the chemical industry. You can explain the use of CO , the source of C and CO 2 .
-
Evaluate the integral, if it exists. Jo y(y + 1) dy
-
Suppose that X and Y are independent random variables, that X has the uniform distribution on the integers 1, 2, 3, 4, 5 (discrete), and that Y has the uniform distribution on the interval [0, 5]...
-
Suppose that the variables X1, . . . , Xn form a random sample from the normal distribution with unknown mean and unknown variance 2. Let 20 be a given positive number, and suppose that it is...
-
In Example 7.9.1, find the formula for p in terms of , the mean of each Xi. Also find the M.L.E. of p and show that the estimator 0(T ) in Example 7.9.2 is nearly the same as the M.L.E. if n is large.
-
Some FIR filters present a rational transfer function: (a) Show that the transfer function \[H(z)=\frac{\left(r^{-1} z ight)^{-(M+1)}-1}{r e^{\mathrm{j} 2 \pi /(M+1)} z^{-1}-1}\] corresponds to an...
-
Show that if two given networks are described by \(Y_{i}=\sum_{j=1}^{M} T_{i j} X_{j}\) and \(Y_{i}^{\prime}=\) \(\sum_{j=1}^{M} T_{i j}^{\prime} X_{j}^{\prime}\), then these networks are...
-
Design second-order lowpass and highpass blocks, and combine them in cascade, to form a bandpass filter with passband \(0.3 \leq \omega \leq 0.4\), where \(\omega_{\mathrm{s}}=1\). Plot the resulting...
Study smarter with the SolutionInn App