Answer to Question #279454 in Macroeconomics for bobby 57

Question

In the coordination failure model, suppose that there is a permanent increase in government spending.

1. Determine how this will affect output and employment. Illustrate graphically by drawing both the labor market and the output market. [15 pts]

2. Will real output become more or less volatile over time? [5 pts]

Answer 1

An increase in government spending that is permanent will raise current real income while lowering the real interest rate. As a result, money demand will increase, and the money demand curve will shift to the right, as seen in the graph. If the central bank does nothing, the price level will fall; as a result, the central bank will need to boost the money supply to stabilize the price level. Because the fiscal authority's actions affect the price level, and the central bank's purpose is to keep the price level under control, monetary policy will be better if the fiscal authority keeps the central bank informed about what it is doing and why.

The fundamental disparities in production and trade patterns between emerging and developed economies are crucial in explaining emerging nations' higher business cycle volatility. This mechanism adds to those previously investigated in the literature, such as disparities in institutional quality, financial development, or the efficiency of public policy, as well as differences in the magnitude and durability of the shocks these economies confront.