In 2009, the U.S. economy was in a severe recession. The Federal Reserve had lowered the...

In 2009, the U.S. economy was in a severe recession. The Federal Reserve had lowered the federal funds rate to about 0 percent, but still wanted to stimulate the economy more. The inflation rate in 2009 was about –1%, but households’ and businesses’ inflation expectations for the upcoming year were higher and positive, about 1.5%.

a) First, do households’ and businesses’ investment demand depend on the ex ante or ex post real interest rate? Briefly explain why.

b) Draw an IS-MP diagram that’s consistent with the state of the U.S. economy in 2009. Make sure that your IS and MP curves intersect in a place that is consistent with the setup of the problem, above. In particular, do your IS and MP curves intersect on the flat part of the MP curve, or the upward-sloping part? And do your IS and MP curves intersect at a positive real interest rate or a negative real interest rate?

c) Suppose that the U.S. Congress and President pass a fiscal stimulus package that increases government spending. Assume that the fiscal stimulus is not large enough to raise nominal interest rates above zero. What effect would this fiscal stimulus have on output and the real interest rate in the short run? Draw a graph to help illustrate your answer.

d) Instead of the fiscal stimulus in part c, above, assume that the Fed announces a major increase in the quantity of bank reserves. As a result, households and businesses become worried that inflation might be higher in the future. What effect would this increase in inflation expectations have on output and the real interest rate in the short run? (Assume that the equilibrium nominal interest rate remains unchanged at 0%.) Draw a graph to help illustrate your answer.

Solutions

Expert Solution

Solution:

Rahul Sunny answered 1 year ago

Next > < Previous

Related Solutions

The Federal Reserve used two unconventional policies to stimulate the economy during the 2007-2009 recession: (1)...

The Federal Reserve used two unconventional policies to stimulate the economy during the 2007-2009 recession: (1) Quantitative Easing and (2) Forward Guidance. Briefly explain these policies and particularly, highlight how these policies worked and explain the channels (transmission mechanisms) through which these policies helped to stimulate the economy.

During 2007-2009, the global economy experienced a severe recession. To deal with recessionary gaps in their...

During 2007-2009, the global economy experienced a severe recession. To deal with recessionary gaps in their economies, many countries implemented expansionary fiscal policies to increase aggregate expenditures. Consider the following hypothetical responses (the actual policies were different in each country). In 2009, the government of the United States introduced a $675 billion stimulus package - additional government expenditures with no changes to the tax system. In Canada, the tax rate was reduced from 33 percent of GDP to 30 percent...

1) In the Great Recession of 2008 -2009, the Federal Reserve resorted to quantitative easing because......

1) In the Great Recession of 2008 -2009, the Federal Reserve resorted to quantitative easing because... Select the correct answer below: a) because it has better results than slashing the federal funds rate b) the interest rates were already down to 0% and the economy was still in deep recession. c) increasing the interest rates did not help the economy d) the unemployment rate was finally starting to decline in 2009 2) Suppose that the economy is producing above the...

Suppose the US economy is in recession. The unemployment rate is 7% and the Federal Reserve...

Suppose the US economy is in recession. The unemployment rate is 7% and the Federal Reserve Bank is considering using monetary policy to expand output. Assume the bank knows, with certainty, that: i. absent changes in monetary policy, unemployment will still be 7% next year; ii. the natural rate of unemployment is 5%; iii. from Okun's law, 1% more output growth for a year leads to a 0.4% reduction in the unemployment rate. Also assume the bank can effectively use...

During the 2007-2009 recession, the Federal Reserve Bank loaned $85 billion to AIG to prevent the...

During the 2007-2009 recession, the Federal Reserve Bank loaned $85 billion to AIG to prevent the large insurance company from filing for bankruptcy. Lehman Brothers filed for bankruptcy during the same week and did not receive any government assistance. The Federal government also insured loans to General Motors and Chrysler. In July, 2008, 5644 companies went bankrupt in the United States. That represented an 80% increase from the previous year. Should the federal government bail out some companies experiencing financial...

In March of this year, the Federal Reserve lowered the reserve requirement to zero. What do...

In March of this year, the Federal Reserve lowered the reserve requirement to zero. What do you think of this? Explain. 2-3 sentences is plenty. Your grade will be based on your explanation (there's not a "right" answer).

Is an allegory of what happened in the U.S. economy during the great recession of 2008-2009....

Is an allegory of what happened in the U.S. economy during the great recession of 2008-2009. Therfore, starting from a position of equilibrium in AD-AS, explain what happened to U.S. economy during the great recession of 2008-2009. what did the U.S. goverment and/or the Fedreal Reserve do to get the U.S. out of recession? What eventually happened in 2015-2016 to improve the U.S. economy, GDP, and unemployment, while also decreasing prices? (Explain graphically and writing)

Suppose the U.S economy is undergoing a severe recession. This means that credit become crunched, investors...

Suppose the U.S economy is undergoing a severe recession. This means that credit become crunched, investors become more risk-averse, corporate liquidity deteriorates, banks are not willing to lend, etc. If this is true, credit spread of any given bond should become narrowed (instead of becoming widened). True or false. Explain.

As the U.S. economy underwent a historic shutdown due to the pandemic, the Federal Reserve was...

As the U.S. economy underwent a historic shutdown due to the pandemic, the Federal Reserve was uncharacteristically bold and swift in pushing out initiatives, facilities, and decisions that have monumental and unusual impacts on the economy, many of these actions go beyond the usual mandate of monetary policy. Please do a little research (including going to the Fed's website) and itemize these actions, along with a brief statement of what each of them does; then add a statement about what...

The U.S. economy is mired in the worst economic downturn since the Great Recession of 2008/2009....

The U.S. economy is mired in the worst economic downturn since the Great Recession of 2008/2009. The decline in U.S. GDP in the first three months of this year was nearly the equal of that during the Great Recession. Real output is expected to fall by six times as much in the second quarter of 2020. The Federal Reserve Board pledged to provide the liquidity needed to prop up the failing economy. The Fed has bought treasury bills and mortgage-backed...

Subjects