Suppose there is a large temporary decline in government purchases in the economy, financed by an unspecified decline in future lump sum taxes.
(a) Analyze the effect of the shock in the labor market diagram of a standard DSGE model (with no sticky prices or wages). What is the effect on the real wage and employment in the short run?
(b) How would your answer change if there are sticky prices?
(c) Discuss how your answer relates to the impulse response functions shown in Figure 15.12.

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FIGURE 15.12 The Dynamic Effects of a Shock to Government Purchases Percent change Percent change -0.5 20 Quarters after the shock 15 20 Quarters after the shock 10 Percent change Percent change 0.4 0.6 0.5 Hours worked 0.2 0.3 1.2 0.1 20 Quarters after the shock 10 15 20 Quarters after the shock 10