Question

1)  Suppose that the fiscal multiplier is the larger one (HINT: use the IS curve with multiplier). Does it help or hurt the government’s ability to use fiscal policy? Why? Do you think the fiscal multiplier is expected to be high in a liquidity trap scenario? Explain why.

2) assume that the central bank follows a standard version of the Taylor rule such that when an increase in inflation is detected, the Central Bank automatically increases interest rates to control it. How would you enhance this Taylor rule to avoid the problem - ( a very flat Phillips Curve)?

Answer 1

The solution of first problem would be........