Econ 2: Spring 2014: UC Berkeley: Econ 2: Sample Final Exam II: F. The Income-Expenditure Framework

Suppose that it is December 2018 and you are in charge of forecasting the state of the economy in 2020. You believe that potential output in 2022 will be $20 trillion, with a 2% inflation rate, and your baseline forecast given current policies for output in 2020 is$19.4 trillion. You also believe that the marginal propensity to consume is 2/3, and you are working in the income-expenditure model. Suppose, also, that you believe the aggregate supply curve is strongly kinked with inflation anchored at 2%/year: that whenever potential output is above actual real expenditure the inflation rate is 2%/year, but if expenditure rises above the level consistent with output equal to potential output times the price level at 2% inflation, inflation accelerates and the price level rises to keep actual output from rising above potential.

1. Suppose that the federal government undertakes an extra $200 billion fiscal stimulus infrastructure construction program for 2020, and the Federal Reserve remains passive. How does this change your forecast of GDP and inflation in 2020? 2. Suppose that the federal government undertakes an extra$400 billion fiscal stimulus infrastructure construction program for 2020, and the Federal Reserve remains passive. How does this change your forecast of GDP and inflation in 2020?

3. Suppose that the federal government undertakes an extra $400 billion fiscal stimulus infrastructure construction program for 2020, but the Federal Reserve acts to keep inflation from rising above 2%/year. How does this change your forecast of GDP and inflation in 2020? What components of GDP do you think rise and what components of GDP do you think fall in this scenario? 4. How would your answer to (1) have been different if potential output were not$20 trillion but $21 trillion? 5. How would your answer to (2) have been different if potential output were not$20 trillion but $21 trillion? 6. How would your answer to (3) have been different if potential output were not$20 trillion but \$21 trillion?