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Transcript
Chapter 14 Answers to pause for thought questions p337 Show the effect of an increase in government expenditure by using the 45 line diagram. The effect is to shift the expenditure function upwards by an amount equal to the increase in government expenditure. The result can be read off as an increase in equilibrium GDP. p339 Give other examples of random shocks. A substantial increase in the world price of oil (as occurred in mid 2004). The Asian currency crisis of 1997. A severe drought. p348 Do you agree that ‘ever more rapid financial flows across the world that are unpredictable and uncertain’ make Keynesian discretionary fiscal (and monetary) policy less suitable? Explain. Discretionary fiscal policy can be undermined by international financial flows. For example, if government expenditure is raised in order to stimulate the economy, the resulting increase in demand for money will drive up the rate of interest. This will lead to an inflow of finance from abroad and an appreciation of the rate of exchange. This will reduce the demand for exports (an injection) and increase the demand for imports (a withdrawal). The effect will therefore be to dampen the rise in aggregate demand. Also, the unpredictability of international financial flows makes the effects of fiscal (and monetary policy) changes less predictable. Note that if there had been a policy of maintaining interest rates at the original level, and thus increasing money supply in line with the extra demand for money, then the above effects would not have occurred. What this means is that if fiscal policy is to be effective, it must be backed up by monetary policy. p352 If there were a gradual increase in the saving rate over time, would this lead to sustained economic growth even without technological progress? Yes, but the rate of economic growth would gradually slow down, given that the Y curve gets less and less steep. If, however, the extra saving were invested in research and development, with the result that the Y curve shifted upwards, this would allow a higher output to result from the extra saving and hence a faster rate of economic growth as saving increased over time.