Question

15. Recently, Trump administration implemented a fiscal stimulus to boost the US economy and fight the covind19. Suppose that 1) output demand is inversely related to real interest rate; 2) nominal interest rate follows the fisher equation; 3) the Fed follows the Taylor rule in implementing the monetary policy to balance the inflation and the unemployment (GDP). 4)The public forms inflations expectations adaptively. 5) The pricing rule follows the expectation-augmented Phillips curve. Apply the DSGE framework to answer the followings:

1. Derive the Dynamics Aggregate Supply curve and the Dynamic Aggregate Demand Curve. Draw the curves in an inflation-output diagram.
2. Show the shift of the equilibrium after Trump’s tax cut, and explain.
3. Suppose Trump’s tax cut lasts for 5 years only. What happens over time?

Answer 1

a) The AD/AS framework implies two ways that inflationary pressures may arise. One possible trigger is if aggregate demand continues to shift to the right when the economy is already at or near potential GDP and full employment, thus pushing the macroeconomic equilibrium into the steep portion of the AS curve.

b)

Supply-side tax cuts are aimed to stimulate capital formation. If successful, the cuts will shift both aggregate demand and aggregate supply because the price level for a supply of goods will be reduced, which often leads to an increase in demand for those goods.

c) The Tax Cuts and Jobs Act was the largest overhaul of the tax code in three decades. The law creates a single corporate tax rate of 21%. Many of the tax benefits set up to help individuals and families will expire in 2025.

The Tax Cuts and Jobs Act was the largest overhaul of the tax code in three decades.

The law creates a single corporate tax rate of 21%.

Many of the tax benefits set up to help individuals and families will expire in 2025.

H&R Block reports that the average tax cut was approximately $1,200 based on the returns the company processed for 2018.