Economics > SOLUTIONS MANUAL > University of California, BerkeleyECON 100BProblemSet-6-Summer2020-Solutions-v1 (All)

University of California, BerkeleyECON 100BProblemSet-6-Summer2020-Solutions-v1

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Econ 100B: Economic Analysis { Macroeconomics Problem Set #6 { Solutions Due Date: August 7, 2020 General Instructions: • Please upload a PDF of your problem set to Gradescope by 11:59 p.m. •... Late homework will not be accepted. • Please put your name, student ID & your GSI’s name at the upper right corner of the front page. 1. Some supply-side economists argue that decreasing taxes will result in higher output at current target inflation with no change in the policy rate. (a) What changes in investment and potential output are supposed to follow from a decrease in taxes according to supply-side economics? Solution: A reduction in taxes is supposed to increase both autonomous investment and potential output. (b) If the assumptions of supply-side economics hold, is is possible for a loss-functionoptimizing central bank to not raise the policy rate? Refer to the optimal-policy rate equation in your answer. Solution: If the economy was in steady-state an increase in autonomous investment would, it an of itself, be inflationary. An increase in I would result in an increase in Y which, via the IS curve, would increase output. An increase in output would result in a positive output gap which, via the Phillips curve, would be inflationary. If, however, there was at the same time an increase in potential output that exactly offset the increase in output due to the increase in I, then the output gap would be zero and there would be no inflation source in the Phillips curve. From the perspective of the optimal-policy rate equation: r(t) = r∗ + 1 ζy γ + βγ 1 π(t) − πT (1) where r∗ = 1 ζY Y − Y P (2) we see that this offset would (i) keep the inflation gap closed and (ii) leave r∗ unchanged. Thus, there would be no need to chang [Show More]

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