1. The foreign exchange value of the US Dollar has declined more than one third since 2001. Assume this change will not reverse itself.
a. What effect will this have on US net exports? Use the AD-AS model to analyze the effect of the change in net exports on US GDP, employment, consumption, investment, inflation, and the budget deficit. Show graphically and explain in detail.
b. What effect will the decline in the Dollar have on AS? Use the AD-AS model to analyze the effect of the change in AS on US GDP, employment, consumption, investment, inflation, and the budget deficit. Show graphically and explain in detail.
c. Combine your analysis in a. & b. to explain the overall impact on US GDP, and inflation. Use your best judgment about the likely path of adjustment from the initial shock to the long run equilibrium. Show graphically and explain in detail.
2. a. The Great Recession began with a collapse in the housing market, which manifested itself as a 50% decline in investment in residential structures. Use the AD/AS model to show the effects of this decline on US GDP and inflation. Show graphically and explain both the short run equilibrium and the adjustment to long run equilibrium, assuming there was no policy response by the US government
In response to the recession, Congress passed the 2009 American Recovery and Reinvestment Act (ARRA). This stimulus package amounted to $787 billion, roughly 2/3 in increased government spending and 1/3 in tax cuts.
b. According to AD/AS analysis, how should the increased government spending affect aggregate demand? Show graphically and explain. )
d. How should the tax cuts affect aggregate demand? Show graphically and explain in detail.
e. Suppose the ARRA stimulus turned out to be half the size of the decrease in investment which caused the recession, and suppose further that the stimulus began to have an impact one quarter the way to the long run equilibrium that would have occurred without any response to the recession by the US government (in a.). Explain the alternative adjustment path that would result from the stimulus and compare it to the adjustment that would have occurred if the government had not responded to the recession. Explain the differences in GDP, employment, consumption, investment, inflation, and the budget deficit.
e. Suppose instead of pe = p-1, people form their inflationary expectations as a weighted average of the past three periods' inflation rates (i.e. pe = 0.5p-1 + 0.33p-2 + 0.17p-3) How does that affect the adjustment process to a shock? Does that strengthen or weaken the case for macro stabilization policy?