Question

3 Foreign country fiscal policy

During the World War I (1914-1918), the UK increases the government spending substantially to finance its military spending. However, the US government spending at that time did not increase much because of its non-intervention policy. Assume there were only two countries in the world, the US was a small open economy and UK was a large country, use IS??LM? model to graphically analyze how the increase of UK government spending change the real exchange rate (pounds/dollar) and the real output in the US, explain in detail.

Answer 1

As recently as two years in the past there used to be a widespread consensus amongst economists that fiscal policy shouldn't be valuable as a countercyclical instrument. Now governments in Washington and all over the world are constructing tremendous fiscal stimulus programs, supported by a huge range of economists in universities, governments, and companies.

Why has this modification occurred? What are the principles for designing a possibly valuable fiscal stimulus? And what will happen if the current fiscal stimulus fails?
I. The upward push and Fall of Fiscal Activism
regardless of a broad array of government programs offered through the Roosevelt administration throughout the despair of the 1930s, the unemployment cost remained at double digit levels until 1941 when the federal government commenced large navy spending for the lend lease software and the begin of World warfare II. Economists saw this favorable influence of the military spending on employment and economic endeavor as a transparent illustration of the power of Keynesian fiscal policy.
After the war, most American macroeconomists concerned about the abilities contribution of Keynesian fiscal policy to preventing unemployment. For some, the new econometric models held out the hope of doing away with or at least greatly damping the business cycle.
But further evaluation and experience soon raised doubts about the efficacy of those new tools. Empirical research indicated that the Keynesian multiplier was much smaller than earlier analyses had assumed, diminished by a crowding out of interest touchy spending brought about by using an precipitated develop in the demand for cash and through the influence of the larger national debt on lengthy-time period curiosity premiums. The leakage of demand through imports and the result of the fiscal enlargement on the alternate expense additional reduced the multiplier.
Despite improvements in knowledge and in econometric approaches, it remained elaborate for economists to investigate the present state of the industry cycle and even more difficult to figure the place the financial system used to be heading and the way so much it will be plagued by a fiscal stimulus. The ensuing uncertainty implied that an activist fiscal policy might in reality develop cyclical volatility. Additionally, the long lags between choices to raise spending or cut taxes and the following fiscal flows mainly intended that the stimulus took place after the trough in undertaking, adding undesirable increases in dem1and to a swiftly increasing economic system. The simultaneous rise in both inflation and unemployment within the Nineteen Sixties made it clear that the Keynesian fiscal technique was no longer working.