Problem Set 2

Problem Set 2 - Economics 134 Spring 2012 Professor...

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Economics 134 Professor Christina Romer Spring 2012 Professor David Romer PROBLEM SET 2 D UE AT THE B EGINNING OF L ECTURE , F EBRUARY 28 You may work together on the problems, but you should try each question yourself and the answers must be written up in your own words. For all questions be sure to explain your answers carefully and to use graphs whenever appropriate. 1. Use the IS-MP-IA model to determine the short-run and long-run effects of a tax cut on output, inflation, the real interest rate, consumption, and investment. Assume that initially the economy is in long-run equilibrium and that it is not constrained by the zero lower bound. 2. This problem asks you to examine the effects of fiscal austerity in the IS–MP model. Specifically, suppose that there are two simultaneous developments. First, government purchases are reduced. Second, the Federal Reserve changes its interest rate rule so that its desired real interest rate for a given level of output and inflation is lower than before. Describe whether the combined effect of these two developments will be to raise, lower, or have no effect (or whether it is not possible to determine the effect) on output and the real interest rate in the short run if: a. Monetary policy is not constrained by the zero lower bound on the nominal interest rate. b.
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Problem Set 2 - Economics 134 Spring 2012 Professor...

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