Question

1. “The depreciation of the dollar from February 2009 to February 2014 had a positive effect on aggregate demand in the United States.” Is this statement true, false, or uncertain? Explain your answer.
2. Why are central banks so concerned with inflation expectations? Draw a graph that illustrates your answer in the short-run.
3. Suppose the public believes that a newly announced anti-inflation program will work and so lowers its expectation of future inflation. What will happen to aggregate output and the inflation rate in the short run? Draw a graph to illustrate your answer.
4. What happens to inflation and output in the short run and long run when government spending increases? Draw two graphs to illustrate your answer, one for the short run and one for the long run.

Answer 1

Ofcourse, A country depreciates their currency in order to increase it's exports and to reduce their import. Hence the net export term increases.

We know that AD = C + I + G + ( X-M)

(X-M) is the net export. Hence with the increase in net export, Aggregate Demand (AD) increases as well.

Now, how that happens? Consider $1 = 70 rupees. Now currency depreciates and $1 = 35.

So you see Indians now would be buying more and more from USA, as they have to pay half the price to get $1 of value of goods in USA. Hence USA's export rises. And If USA were importing from India, they need to pay twice as much, as with 1$ they can only buy Rs 35 worth of good.

SO THE STATEMENT IS TRUE

The central bank should remain concerned regarding the expected inflation. To see why

we know nominal interest rate = real interest rate + expected inflation rate. hence with the increase in the expected inflation rate the nominal interest rate in the present also rises. as people see that nominal interest rate is actually on the rise they keep less money in their hands and deposit the rest ( maximum amount) of the money in the bank. hence real demand for money actually decreases. Real demand for money is denoted by (M/P)d

And Money supply is denoted by ( M/P)s = M/P

WHERE M means Money supply ( which is not changed ) so the only thing that can Increase is the Price, so that ( M/P)s i.e Real supply of money falls to equilibriate with Real demand for money ( which fell before)

IN OTHER WORDS IF THE EXPECTED INFLATION RISES, ACTUAL PRICES MAY RISE IN SHORT RUN

To put it in other words, If the government tells us that they are going to impose an increase in tax of a certain good that will increase it's price later in future, the people of today will demand more and more. Hence with the existing supply, a sudden influx of demand, will increases the prices of today. Hence the central bank should be careful

I will be attaching a demand supply graph at the end and will name it as A

Now if government assures that a new anti Inflation policy will work in the future, so people will understand that the prices will fall in the future. Hence they would decrease their demand in the current scenario leading to the fall in current prices and quantity demanded.

I will attach the picture and name it as B

AD = C+I+G+(X-M)

So increase in G will lead to the shift of the AD curve towards the right.

Considering AD-AS curves, an increase in the government expenditure in the keynesian zone (short run) will cause an increase in the Output but no Inflation. In classical stage, an increase in government expenditure will only lead to the increase in prices and not output.

I am attaching pictures naming these as C and D



A AND B PICTURES SHOWING EXPECTED INFLATION AND DEFLATION.