1. The outbreak of the bubonic plague- the Black Death- in 1348 reduced the population of Europe by about one-third within a few years, which resulted in a massive reduction in the labor force during the plague years. Suppose the outbreak of the bubonic plague- the Black Death- in 1348 did not cause the TFP parameter to fall (this is a reasonable assumption for simplicity as the effect of the fall in TFP was much less significant than the effect of the massive reduction in the labor force during the Black Death, so the effect of the fall in TFP was negligible compared with the massive reduction in the labor force during the Black Death). Using the complete intertemporal model developed in class, briefly explain the effects of the outbreak on the equilibrium values of real wage, output, real interest rate, consumption, investment, and the price level.
2. The government decreases lump sum taxes in the current period, while holding government spending in the present and the future constant. Consider the complete intertemporal model without credit market frictions developed in class, briefly explain what are the equilibrium effects of this policy on consumption, investment, the real interest rate, aggregate output, employment, and the real wage? What would the central bank do if the objective of the central bank is to maintain price stability?