Question

Consider the following model of an open economy: C = 14000 + 0.9YD - 45000i YD...

  1. Consider the following model of an open economy:

    C = 14000 + 0.9YD - 45000i

    YD = Y - T

    I = 7000 - 20000i

    M = 0

    G = 7800

    X = 1800

    where Y is income, C is consumption, YD is disposable income, i is the real interest rate,G is government spending, T is tax, I is investment, M is imports, and X is exports.

    1. What is the marginal propensity to save? (1 MARK)
    2. Explain the intuition behind the investment function.
    3. Find the numerical equation relating the short-run equilibrium output as a function of the real interest rate
    4. What is the value of the multiplier?
    5. If the economy is at full employment when Y =  104000 then at what value should the Reserve Bank set the real interest rate to eliminate the gap between potential output and the short-run level of output.
    6. Explain the Taylor rule.
    7. Supposing the Reserve Bank follows the Taylor rule. Find the real interest rate and the nominal interest rate when inflation is at 2 percent and the output gap is -5 percent of GDP. That is the economy is in a deep growth recession.
    8. Can the Reserve Bank set a negative interest rate? If so how?
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