Econ 736 Analytical Assignment #3 1. (10 points) 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. (10 points) 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. 3. (10 points) Using the AD/SRAS/LRAS model (with the sticky price version of the SRAS model), graph the impact of the coronavirus (COVID‐19) on the US economy. What should happen to output and inflation in the short run? In the absence of policy intervention (by either the fiscal or monetary authorities), what would happen to output and inflation in the long run? 4. (10 points) Consider the inflation and unemployment data in the table below for the United States between 1990 and 2005. Year 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Unemployment U 5.6 6.9 7.5 6.9 6.1 5.6 5.4 4.9 4.5 4.2 4.0 4.7 5.8 6.0 5.5 5.1 Natural Rate Unemployment Un 6.1 6.4 6.5 6.4 6.2 5.8 5.4 5.0 4.8 4.6 4.6 4.8 4.9 5.0 5.1 5.2 Inflation 5.4 4.2 3.0 3.0 2.6 2.8 3.0 2.3 1.6 2.2 3.4 2.8 1.6 2.3 2.7 3.4 You may assume that Okun’s Law holds true (i.e. 1% of unemployment is approximately equal to 2% of lost output). Recall that the sacrifice ratio is calculated as: Econ 736 Analytical Assignment #3 Sacrifice Ratio Lost Output Inflation Using the data above, calculate the sacrifice ratio for the US economy between the 1990‐2005 period (overall). What value would the sacrifice ratio be under adaptive expectations? What value would it be under rational expectations? Based on the answer you calculated above, can you say anything about whether people in the economy form expectations based on rational expectations or adaptive expectations? [Note: you do not have to calculate the value of the sacrifice ratio under adaptive or rational expectations here; rather, you may simply state what values they would be.] …

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Econ 736 Analytical Assignment #3 1. (10 points) 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. (10 points) 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. 3. (10 points) Using the AD/SRAS/LRAS model (with the sticky price version of the SRAS model), graph the impact of the coronavirus (COVID‐19) on the US economy. What should happen to output and inflation in the short run? In the absence of policy intervention (by either the fiscal or monetary authorities), what would happen to output and inflation in the long run? 4. (10 points) Consider the inflation and unemployment data in the table below for the United States between 1990 and 2005. Year 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Unemployment U 5.6 6.9 7.5 6.9 6.1 5.6 5.4 4.9 4.5 4.2 4.0 4.7 5.8 6.0 5.5 5.1 Natural Rate Unemployment Un 6.1 6.4 6.5 6.4 6.2 5.8 5.4 5.0 4.8 4.6 4.6 4.8 4.9 5.0 5.1 5.2 Inflation 5.4 4.2 3.0 3.0 2.6 2.8 3.0 2.3 1.6 2.2 3.4 2.8 1.6 2.3 2.7 3.4 You may assume that Okun’s Law holds true (i.e. 1% of unemployment is approximately equal to 2% of lost output). Recall that the sacrifice ratio is calculated as: Econ 736 Analytical Assignment #3 Sacrifice Ratio Lost Output Inflation Using the data above, calculate the sacrifice ratio for the US economy between the 1990‐2005 period (overall). What value would the sacrifice ratio be under adaptive expectations? What value would it be under rational expectations? Based on the answer you calculated above, can you say anything about whether people in the economy form expectations based on rational expectations or adaptive expectations? [Note: you do not have to calculate the value of the sacrifice ratio under adaptive or rational expectations here; rather, you may simply state what values they would be.] …
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