Answer to Question #282474 in Macroeconomics for ABEX

Question

3. Suppose a country targets an income level of Y ∗.

(a) Demonstrate, using graphs, that either fiscal or monetary policies

can be used to achieve the targeted level of income.

(b) What are the possible reasons for a country to opt for a particular

policy (fiscal or monetary) while both of them can yield similar

level of income?

4. A country faced an unexpected build-up of foreign exchange earning

following a positive price shock on the country’s main export in the international market. This gain was, however, accompanied by a soaring

inflation. How and under what conditions, if any, can the build-up of

the foreign exchange reserve trigger inflation?

Answer 1

3.

(a) Both monetary and fiscal policies are used to regulate economic activity over time. They can be used to accelerate growth when an economy starts to slow or to moderate growth and activity when an economy starts to overheat. In addition, fiscal policy can be used to redistribute income and wealth. Both policies can affect either AD or AS curves to change the equilibrium level of income.

(b) The country may opt for a particular

policy (fiscal or monetary), because both of them are good in different situations and have their own pros and cons.

4. The build-up of the foreign exchange reserve can trigger inflation, if the reaulting increase in equilibrium income will be above the potential level.