1. The effects of fiscal policy: Analyse the effects on real GDP Y of a temporary increase in government spending G financed by running a
1. The effects of fiscal policy: Analyse the effects on real GDP Y of a temporary increase in government spending G financed by running a budget deficit (so future taxes T' increase) in the following cases. Comment on whether it is possible for Y to rise by more than G. (a) An economy with flexible prices and no credit-market imperfections such as borrowing constraints. (b) An economy with completely sticky prices, no credit-market imperfections, and where the central bank keeps interest rates constant. (c) An economy with completely sticky prices, no credit-market imperfections, and where the central bank sets the interest rate equal to the 'natural rate of interest'. (d) An economy with flexible prices where some (but not all) households face binding limits on how much they can borrow. Suppose the government decides to cut taxes (lowering T) instead of increasing G, still financed by running a budget deficit. (e) In cases (a) and (d) above, what difference does this change make to the impact on real GDP Y? 2. Seigniorage profits of central banks: In the last 15 years, central banks such as the Federal Reserve and the Bank of England have made large outright purchases of long-term government bonds with reserves that now pay interest. In the last few years, these central banks have raised the interest rate paid on reserves. Explain how these developments affect the profitability of central banks compared to the methods of conducting monetary policy in use prior to the 2008 financial crisis
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