Assume that the United States is experiencing an inflationary gap. If no action is taken by the Federal Reserve or the government, what effect will the lack of policy change have on nominal wage and real output in the long run? Nominal Wages Real Output A. Increase Decrease B. Increase Increase C. Decrease Stay the same D. Decrease Increase E.DecreaseDecrease
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An inflationary gap occurs when the actual output of an economy exceeds its potential output, leading to upward pressure on prices and wages. Show more…
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Greenburg's economy is in short-run equilibrium with an inflationary gap of $48 billion and the marginal propensity to save is 0.25. The expected inflation rate is 8%, and the natural rate of unemployment is 7%. (a) Based on the Phillips curve model, is the actual inflation rate greater than, less than, or equal to the expected inflation rate of 8% in Greenburg? Explain. (b) Assume the government takes no policy action with regard to the state of Greenburg's economy. (i) What will happen to the actual rate of unemployment in the long run? Explain. (ii) How will the long-run adjustment process be represented in the Phillips curve model? Explain. (c) Assume that instead of waiting for the long-run adjustment, the government of Greenburg is considering using fiscal policy to address the inflationary gap of $48 billion. (i) If the government chooses to decrease its deficit spending, calculate the minimum change in government spending required to decrease aggregate demand by the amount of the inflationary gap. Show your work. (ii) How will the effect of the government's action in part (c)(i) be represented in the Phillips curve model? Explain. (iii) If the government chooses to increase income taxes instead of decreasing its spending, calculate the minimum change in income taxes required to decrease aggregate demand by the amount of the inflationary gap. Show your work. (iv) Now suppose instead that the government wants to maintain a balanced budget and increases both government spending and income taxes by $40 billion. Will this policy make the output gap smaller, make the output gap larger, or have no effect on the output gap? Explain. (d) Suppose the government chose to implement only the policy described in part (c)(i). Based on loanable funds market analysis, what will happen to each of the following? (i) The price of previously issued bonds. Explain.
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