Question

Below are pairs of economic outcomes in (a)-(e). For each pair, provide 1 Determinant Change or 1 Monetary Policy stance (Expan or Contr) or 1 Fiscal Policy stance (Expan or Contr) that could cause the pair of outcomes. Changes/Stances may be repeated.

a. Real GDP rises, Exchange Rate depreciates

b. Real Interest Rate rises, Unemployment falls

c. Inflation falls, Budget Balance moves toward deficit

d. Real GDP rises, Official International Reserves rise

e. Real Interest Rate falls, Budget Balance moves toward deficit

Answer 1

(a) Expansionary Monetary policy

An increase in money supply will decrease interest rate which will increase domestic investment and increase aggregate demand, shifting AD curve right and increasing real GDP. Also, lower interest rate will reduce foreign investment in the country, lowering the demand for domestic currency, depreciating exchange rate.

(b) Expansionary Fiscal policy

An increase in government spending or decrease in tax will increase aggregate demand, raising real GDP and lowering unemployment. At the same time, budget deficit will rise, increasing government spending (for deficit financing) which will increase real interest rate.

(c) Contractionary Monetary policy

A decrease in money supply will increase interest rate which will decrease domestic investment and decrease aggregate demand, shifting AD curve left and decreasing price level (inflation) and decreasing real GDP. Also, lower real GDP will increase unemployment which will reduce tax base, decreasing tax revenue and moving the budget balance towards deficit.

(d) Expansionary Fiscal policy

An increase in government spending or decrease in tax will increase aggregate demand, raising real GDP and lowering unemployment. At the same time, budget deficit will rise, increasing government spending (for deficit financing) which will increase real interest rate. Higher interest rate will attract foreign investment, increasing the demand for domestic currency and increasing the supply of foreign currency, which will increase Official International Reserves.

NOTE: As per Answering Policy, 1st 4 parts are answered.