East Malvidas is a small island country with big economic problems. Currently the unemployment rate is 16 percent and the price level is increasing at a rate of 20 percent a year. Gross Domestic Product fell again this year, marking the second straight year of a prolonged recession. Income taxes (where the federal government receives most of its revenue) are highly progressive and the top marginal tax rate is 90 percent, impacting the incomes of 30 percent of the population.
Over the past several years the money supply has been increasing at a 30 percent annual rate and the country has run both a federal budget surplus and a trade surplus. Tariffs on foreign goods are some of the highest in the world and many countries have retaliated by placing quotas on exports from East Malvidas. Thus, exports are a small part of the country's economic output.
With national elections two years away, the governing authorities are anxious to get the economy turned around before they have to stand for reelection.
You have been hired by the government of East Malvidas and given vast power to recommend both monetary and fiscal policy. What will be your recommendations to improve the economy?
1. What would be the appropriate fiscal policies (taxes and spending) given the current economic situation? (Be specific with regard to the effects of these policies on particular groups.) What problems might your recommendations best address? Why?
2. What types of monetary policy might be best for addressing the current situation (and which tools would you use to enact these policies)? What problems might your recommendations best address? Why?
3. How might you address the current situation with respect to international trade? What policies would you recommend and how will these policies improve on the current situation? Identify the likely beneficiaries of your policies and who might be opposed to your recommendations.