Q3. Monetary and fiscal policy to manage the economy and growth The small industrial economy of Belgand wants to have FEWPS (full-employment with price stability). The economy has the following characteristics (millions of Belgmarks) "i" denoted interest rate. The equilibrium output is currently: Asset Demand Interest-determined Ya* 8000 for Money part of desired investment i i I(i) Marginal propensity to consume 0.8 MPC = Full employment level of output (Potential GDP) Yp = 7000 The money supply is 520. 2220.125 Banks must keep a 12.5% required reserve ratio (RR) against deposits. No excess reserves. 12 11 10 9 8 7 6 5 Md 4 160 240 320 400 440 480 520 660 920 | 1000 12 11 10 m 9 8 7 6 5 4 3 Interest-determined part of investment "I(i)" and the demand for money "Md" are shown to the right. The money supply is defined as "demand deposits" (ignore transaction demand). 1) Sketch and label economic conditions on graph. Calculate the multiplier and the income and Aggregate expenditure gap. NOW assume each of the following policies are pursued separately 3) What changes in government spending are necessary to reach FEWPS? 4) What changes in taxes are necessary to reach FEWPS? Explain and show work. 5) If the government budget is balanced to start with, should the government try to balance the budget with Tx = G + Tr under the economic conditions in this problem or should it run a surplus or deficit AND WHY? Using Monetary Policy to achieve similar goals. Remember the Fed is more or less independent of the Executive Branch of the US Government. Its goals are to manage money and credit to manage stability and growth in the economy. | 100 | 200 250 300 350 400 500 700 | 1000 | 2000 MS Mo 520 6) What monetary policy should the Belgand central bank pursue? Specifically, what instructions would you give to their "open market committee" and what specific changes would you expect in reserves (R), money supply (Ms), interest rates (i), planned investment (Id), and equilibrium GNP? 7. In 6, would you buy or sell bonds and how many and why? 8) In 6, would you lower or raise the discount rate as part of this policy? Why? 9) Let us assume that Belgand has reached FEWPS by only using "fiscal policy". A government advisory board urges a new policy to stimulate growth and labor productivity by investing 200 (million Belmarks) in modern plant and equipment. What specific changes in taxes and monetary policy would you recommend to achieve this new growth without causing inflation?