Solutions Econ 116b Final 2005
A higher MPI lowers the government multiplier because of increased spending (i.e.
consumption) leakages to imports.
So, if the US has the higher MPI, fiscal policy here would be
less effective than in Germany.
Monetary policy does have a shorter implementation lag than fiscal policy,
but the implementation lag is not the only (and probably not the best) indicator of effectiveness.
First, despite having the higher implementation lag, fiscal policy has a much shorter response lag
from the moment of implementation.
Second, the relative effectiveness of fiscal and monetary
policy depends on the slopes of the IM and LS curves.
Consumption per worker is lower for savings rates beyond the golden rule rate of
Monetary policy has no effect with fixed exchange rates, so monetary policy under
flexible exchange rates must be more effective by definition.
Unlike the case of bond prices, stock prices depend on more than just the interest rate –
stock prices could have decreased in this case due to lower future expected dividends on the stock.
Relative to a model with trade and no feedback, the feedback effect improves the effect
of government spending.
This occurs through a virtuous loop where the increase in the trade
partner’s export earnings and output leads them to increase their imports, in turn increasing the
first country’s exports, and thus further increasing its output.
The life cycle theory is based on the premise that consumers seek to smooth
consumption over time – so consumption should be steady no matter if the consumer is young (a
net borrower), in his or her middle productive years (a net saver), or old (a net dissaver).
The unemployment rate can be expressed as u = U/[E+U], where [E+U]=L is the
number of individuals actively seeking work (i.e. the labor force) and E is the number of the
employed, and U, the unemployed. Similarly, the employment rate is e = E/[E+U].
Hence, e + u = U/[E+U] + E/[E+U] = 1, and so it is not possible for the unemployment and the
employment rates to increase simultaneously.
(The level of unemployment and employment can
increase simultaneously, indicating a growth of the labour force.)
The Fed can intervene in the foreign exchange market directly by changing the US
If the Fed does not wish to alter the money supply or interest rates (thus disturbing
the domestic equilibrium) it could also intervene with a process known as currency sterilization.
This strategy would entail the Fed buying foreign currency with US bonds, or, alternatively,
buying foreign currency with USD and simultaneously selling an equivalent amount in US
Treasury bonds on the domestic market, thereby avoiding any change in the domestic money