Answer to Question #95461 in Macroeconomics for primus

Question

. Suppose the economy is operating at the zero lower bound for the nominal policy rate, the economy is operating at potential output in period t, but there is a large government budget deficit. A newly elected government vows to cut spending and reduce the deficit in subsequent periods. Use an IS-MP-PC diagram to answer the following questions:
a. What is the effect of the policy on output in period t+1 (5 marks)
b. What is the effect of the policy on inflation in period t+1 (5 marks)
c. Discuss how to get out of liquidity in such a scenario (5 marks)s
d. Discuss how fiscal consolidation will be difficult in such an environment (5 marks)

Answer 1

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