Question

need all parts answered

Business cycle models with flexible wages and prices

Suppose the Central bank is conducting an expansionary monetary policy, in the new monetarist model by issuing outside money and exchanging it for government bonds on the open market.

1) What are its effects on FLA? Illustrate the equilibrium effects of this on aggregates variables. Does it matter if there is a liquidity trap where excess reserves are held in the financial system? If so why? and if not, why not? explain.

Part 2

Suppose the government increases its expenditures for a short term. What would the macroeconomic effects be? Based on the results of your analysis, do you think variations in government expenditures could explain the fluctuations we observe in business cycles? Why or why not?

Answer 1

Part 1 :
Suppose the Central bank is conducting an expansionary monetary policy, in the new monetarist model will be as follows:

Monetarists contend that inflation is fundamentally a monetary phenomenon. A surplus of money, they argue, will inflate the money price of everything in the economy.
Stated in terms of straightforward supply and demand relationships, a surplus of money would bring down its value just as a surplus in any market would bring down the price of the product in excess.

In the given question effects will be the the inflation will increase. . The excess of money creates the inflation by increasing liquidity, which ultimately causes a rapid rise in demand.

In this sense, the Monetarist argument is a special case under the more general heading of demand- pull concepts of inflation.

Part2:
When government increases its expenditures for a short term, the macroeconomic effects will be the economy will do better,aggregate demand will increase ,employment will increase and lead to increase in supply. This will lead increase in the economic activites.

When crises occur, the government should intervene to keep capital and labor employed by deliberately running a larger fiscal deficit.

This intervention would limit the damages of major recessions. Although this concept continues to be a highly politically charged debate, many economists agree that government expenditure can limit the negative effect of major economic crises in the short term.

A typical business cycle consists of four phases: trough, expansion, peak, contraction.

The period of expansion occurs after the trough lowest point of a business cycle and before its peak highest point. The peak and trough represent turning points in the cycle. Contraction is the period after the peak and before the trough.

During the expansion phase, aggregate economic activity is increasing .The contraction—often called a recession, but may be called a depression when exceptionally severe.
Government expenditure spending volatility can cause the business cycles, the higher spend will cause the expansionary impact and reduced expenditure will have contractionary impact.