Workbook For Chapter 5 Of Blanchard Macroeconomics. Part A Problem 7 The Bush-Greenspan policy mix. In 2001, the Fed pursued a very expansionary monetary policy. At the same time, President George W. Bush pushed through legislation lowering income taxes. a. Using the IS-LM diagram, illustrate the effect of such a policy mix. i Y b. How does this policy mix differ from the Clinton-Greenspan policy mix? c. What actually happened to output in 2001? If you don’t remember, look at table 1.1 on page 4. __________________________________________________. d. Read “The Current Slowdown” starting on page 5. What else happened in 2001? Draw the effect of the events before the policy reaction. i Y What should have happened to output? ________________. What would have happened to output if policy had not reacted the way it did? ________________________________.Problem 4 Consider the following IS-LM model. 1600/80002)/(200250100025.015025.0200=−===−+=+=PMiYPMTGiYIYCdD a. Derive the IS relation, simplifying. (Put all the Y’s on the right-hand side.) Y= __________ ______________________________________________________. b. Derive the LM relation. i = _________________________________________________________________. c. By plugging one into the other, solve for equilibrium real output. Y = ________________________________________________________________. d. By plugging equilibrium real output into IS or LM, solve for the equilibrium interest rate. i = ________________________. e. Solve for equilibrium real values of C and I and double-check the value you obtained for Y by adding up C + I + G. C = ______________. I = ___________. f. Now suppose that the money supply increases to M/P = 1840. solve for Y, I , C, and I, and describe in words the effect of an expansionary monetary policy on these variables. Y = __________. i = _______. C = __________. I = _______. ___________________________________________________________________ ___________________________________________________________________. g. Set M/P back to its initial value of 1600. Now suppose that government spending increases to G = 400. Summarize in words the effects of an expansionary fiscal policy on these variables. Y = ______. i = _____. C = ______. I = ______. ______________________________________________________________________________________________________________________. Problem 2 Consider first the goods market model with constant investment that we saw in Chapter 3. ),(10TYccC−+= and I, G, and T are given. a. Solve for equilibrium output. That is, plug the above behavioral equations into Y = C + I + G, and solve for Y = ________________________. What is the value of the multiplier? __________________. Now, let investment depend on both sales and the interest rate. ibYbbI210−+= b. Solve for equilibrium output. Y = __________________________________. This equation is called the IS relation because it relates equilibrium output with the interest rate in the goods market. Now what is the value of the multiplier? __________________. At a given interest rate, is the effect of a change in autonomous spending bigger that what it was in (a)? In other words, is the multiplier smaller or larger in this case? (assume c1 + b1 < 1)______________. Why? Give the economic reason:______________________________________________________________ ____________________________________________________________________ ____________________________________________________________________. Next, write the LM relation as. idYdPM21/−= c. Solve the IS relation and the LM relation for the interest rate. Solve the LM relation for i. i = ____________________________________________.In IS-LM equilibrium the two interest rates are equal. Therefore, plug the LM relation into the IS equation.___________________________________________ ____________________________________________________________________ ___________________________________________________________________. Now solve this equation for Y to get equilibrium output in the short run, Y = ____________________________________________________________________. Find the multiplier. In other words, what is the effect of a change of 1 unit of autonomous expenditure on output? ___________________________________. d. Is the multiplier you obtained in part (c) bigger or smaller than the one from part (a)? ___________. Your answer should depend on the parameters in the behavioral equations for consumption, investment, and money demand. Let’s make hypotheses about the parameters. Suppose that investment is very sensitive to output (large b1), that investment is not very sensitive to the interest rate (small b2), that money demand is not very sensitive to output (small d1), money demand is very sensitive to the interest rate (large d2). Suppose that G rises, _______ (raising/lowering) equilibrium GDP. Because investment is very sensitive to output, I will ______ (fall/rise) by a ________ (lot/little). Now, because money demand is not very sensitive to output, this change in output will cause money demand to ______ (fall/rise) by a ________ (lot/little). This change in money demand will in turn affect the interest rate. For a given change in money demand, how much will the interest change? We’ve assumed that money demand is very sensitive to the interest rate. This means that a small change in interest rates will cause quantity of money demanded to change by a ________ (lot/little), making the Md curve very ________ (flat/steep).i Md M Now, take a given increase in income which shifts the Md horizontally by a given amount (this is shown in the graphs by the arrow, which has the same length in both cases). If the Md curve is flat (left-hand graph), an increase in income that shifts the money demand curve to the right will raise interest rates very little. But if the Md curve is steep (right-hand graph), the horizontal shift will raise interest rates by a lot. i Ms Ms Md’ Md Md Md’ M M Since we’ve assumed that money demand is very sensitive to the interest rate, we know that the Md curve is very ________ (flat/steep), and that a given increase in Md will cause interest rates to rise by a ________ (lot/little). In this particular case, given what you found above about what happened to money demand, we know that interest rates will ______ (fall/rise) by a ________ (lot/little). Now let’s