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CHAPTER16ANSWERSTOTEXTBOOKPROBLEMS1.Adeclineininvestmentdemanddecreasesthelevelofaggregatedemandforanyleveloftheexchangerate.Thus,adeclineininvestmentdemandcausestheDDcurvetoshifttotheleft.2.Atariffisataxontheconsumptionofimports.Thedemandfordomesticgoods,andthusthelevelofaggregatedemand,willbehigherforanyleveloftheexchangerate.Thisisdepictedinfigure16-1asarightwardshiftintheoutputmarketschedulefromDDtoD'D'.Ifthetariffistemporary,thisistheonlyeffectandoutputwillriseeventhoughtheexchangerateappreciatesastheeconomymovesfrompoint0topoint1.Ifthetariffispermanent,however,thelong-runexpectedexchangerateappreciates,sotheassetmarketscheduleshiftstoA'A'.Theappreciationofthecurrencyissharperinthiscase.Ifoutputisinitiallyatfullemploymentthenthereisnochangeinoutputduetoapermanenttariff.012AAA’A’DD’DD’YEYfFigure16-13.Atemporaryfiscalpolicyshiftaffectsemploymentandoutput,evenifthegovernmentmaintainsabalancedbudget.Anintuitiveexplanationforthisreliesuponthedifferentpropensitiestoconsumeofthegovernmentandoftaxpayers.Ifthegovernmentspends$1moreandfinancesthisspendingbytaxingthepublic$1more,aggregatedemandwillhaverisenbecausethegovernmentspendstheentire$1whilethepublicreducesitsspendingbylessthan$1(choosingtoreduceitssavingaswellasitsconsumption).Theultimateeffectonaggregatedemandisevenlargerthanthisfirstrounddifferencebetweengovernmentandpublicspendingpropensities,sincethefirstroundgeneratessubsequentspending(Ofcourse,currencyappreciationstillpreventspermanentfiscalshiftsfromaffectingoutputinourmodel.)4.ApermanentfallinprivateaggregatedemandcausestheDDcurvetoshiftinwardandtotheleftand,becausetheexpectedfutureexchangeratedepreciates,theAAcurveshiftsoutwardandtotheright.Thesetwoshiftsresultinnoeffectonoutput,however,forthesamereasonthatapermanentfiscalexpansionhasnoeffectonoutput.Theneteffectisadepreciationinthenominalexchangerateand,becausepriceswillnotchange,acorrespondingrealexchangeratedepreciation.Amacroeconomicpolicyresponsetothiseventwouldnotbewarranted.012AAA’A’DD’DD’YEXXFigure16-25.Figure16-2canbeusedtoshowthatanypermanentfiscalexpansionworsensthecurrentaccount.Inthisdiagram,thescheduleXXrepresentscombinationsoftheexchangerateandincomeforwhichthecurrentaccountisinbalance.PointsaboveandtotheleftofXXrepresentcurrentaccountsurplusandpointsbelowandtotherightrepresentcurrentaccountdeficit.ApermanentfiscalexpansionshiftstheDDcurvetoD'D'and,becauseoftheeffectonthelongrunexchangerate,theAAcurveshiftstoA'A'.Theequilibriumpointmovesfrom0,wherethecurrentaccountisinbalance,to1,wherethereisacurrentaccountdeficit.If,instead,therewasatemporaryfiscalexpansionofthesamesize,theAAcurvewouldnotshiftandthenewequilibriumwouldbeatpoint2wherethereisacurrentaccountdeficit,althoughitissmallerthanthecurrentaccountdeficitatpoint1.6.AtemporarytaxcutshiftstheDDcurvetotherightand,intheabsenceofmonetization,hasnoeffectontheAAcurve.Infigure16-3,thisisdepictedasashiftintheDDcurvetoD'D',withtheequilibriummovingfrompoint0topoint1.Ifthedeficitisfinancedbyfuturemonetization,theresultingexpectedlong-runnominaldepreciationofthecurrencycausestheAAcurvetoshifttotherighttoA'A'whichgivesustheequilibriumpoint2.Theneteffectontheexchangerateisambiguous,butoutputcertainlyincreasesmorethaninthecaseofapurefiscalshift.012AAA’A’DD’DD’YEFigure16-37.AcurrencydepreciationaccompaniedbyadeteriorationinthecurrentaccountbalancecouldbecausedbyfactorsotherthanaJ-curve.Forexample,afallinforeigndemandfordomesticproductsworsensthecurrentaccountandalsolowersaggregatedemand,depreciatingthecurrency.Intermsoffigure16-4,DDandXXundergoequalverticalshifts,toD'D'andX'X',respectively,resultinginacurrentaccountdeficitastheequilibriummovesfrompoint0topoint1.TodetectaJ-curve,onemightcheckwhetherthepricesofimportsintermsofdomesticgoodsrisewhenthecurrencyisdepreciating,offsettingadeclineinimportvolumeandariseinexportvolume.01AADD’DD’YEXXX’X’Figure16-48.Theexpansionarymoneysupplyannouncementcausesadepreciationintheexpectedlong-runexchangerateandshiftstheAAcurvetotheright.Thisleadstoanimmediateincreaseinoutputandacurrencydepreciation.Theeffectsoftheanticipatedpolicyactionthusprecedethepolicy'sactualimplementation.01AADD’DD’YEXXA’A’D”D”2Figure16-59.Ifexchangeratepass-throughisincompleteintheshort-runthentheDDcurvebecomessteeper;agivenappreciationoftheexchangeratecrowdsoutlessimportsbecausetheforeigncurrencypriceoftheseimportsfallsconcurrentwiththeappreciationofthecurrency.Inthiscase,apermanentfiscalexpansionbothshiftsouttheDDcurveand,becauseofpricingbehaviorbyforeignexporters,makesitsteeper.Thisresultsinanincreaseinoutputalongwithacurrentaccountdeficit,asdepictedinfigure16-5byashiftfromDDtoD'D'whichshiftstheequilibriumpointfrom0to1.Overtime,astheforeigncurrencypriceofimportsrise,theslopeoftheDDreturnstoitsoriginalvalue,whichreducesoutputandoffsets,tosomeextent,thecurrentaccountdeficit.Inthediagram,thisisdepictedasamovementfrompoint1topoint2withaflatteningoftheoutputmarketcurvefromD'D'toDD.Thus,lowgovernmentandprivatesavingscausedthecurrentaccountdeficit,butincompletepass-throughexacerbatedtheinit