ANALYTICAL PROBLEMS

1. Recessions often lead to calls for protectionist measures to preserve domestic jobs. Suppose that a country that is in a recession imposes restrictions that sharply reduce the amount of goods imported by the country.

a. Using the Keynesian IS-LM model, analyze the effects of import restrictions on the domestic coun­try's employment, output, real interest rate, and real exchange rate, keeping in mind that the coun­try is initially in a recession.

b. What are the effects of the country's action on for­eign employment, output, real interest rate, and real exchange rate? What happens if the foreign country retaliates by imposing restrictions on goods exported by the domestic country?

c. Suppose that the domestic economy is at full employment when it imposes restrictions on imports. Using the basic classical model without misperceptions, find the effects on the country's employment, output, real interest rate, and real exchange rate.

2. After the financial crisis reached Europe in 2008, a lot of EU citizens sold their euro investments and con­verted the money into Swiss francs or gold. Why did they do this? What impact did this have on the exchange rates of the euro and Swiss franc and the price of gold? Use the classical IS-LM model to describe the effects on the European economy and the Swiss economy.

3. The Greek government-debt crisis started in late 2009 and forced the European Union and the European Central Bank (ECB) to adapt their policies in order to save Greece from bankruptcy.

a. What was the effect of the problems in Greece and other struggling eurozone countries on the exchange rate of the euro and the eurozone's economy?

b. Which monetary policy instruments did the ECB use to stabilize the economy and create demand?

c. Suppose that Greece left the eurozone and introduced the Greek drachma again. Describe some advantages and disadvantages of this.

4. Use a diagram like that in Fig. 13.7a to analyze the effect on a country's net exports of a beneficial supply shock that temporarily raises full-employment out­put by 100 per person. Assume that the basic classical model applies so that income is always at its full­employment level.

a. Suppose that, in response to the temporary increase in income, the residents of the country do not change the amount they desire to spend at any real interest rate (on either domestic or foreign goods). What is the effect of the supply shock on the country's net exports? (Hint: What is the effect of the increase in income on the curve representing desired saving minus desired investment? What is the effect on the curve representing net exports?)

b. Now suppose that, in response to a temporary increase in income, the residents of the country increase their desired spending at any real interest rate by 100 per person. A portion of this increased spending is for foreign-produced goods. What is the effect on the country's net exports?

c. More difficult: If the increase in income is tempo­rary, would the spending behavior assumed in part (a) or the spending behavior assumed in part (b) be more likely to occur? Based on your answer, do the results of this problem confirm or contra­dict the prediction of the model in Chapter 5 of the response of net exports to a supply shock? Explain.

5. Consider the theoretical impact of a trade war, with increased tariffs imposed by all major countries in the world. Suppose that the trade war 's main effect is to reduce the benefits of comparative advantage, so that countries no longer specialize in goods as much as before and that therefore the production function shifts down because of the loss of the gains from trade. How is this likely to affect the curves in the IS-LM model? (Hint: You might begin the analysis by assuming that the trade war affects both imports and exports equally, so that there is no impact on net exports.) First, analyze the long-run impact of the trade war in a classical model, assuming that labor supply is not affected. Second, consider the short-run impact in a Keynesian model, in which the tariffs ini­tially cause reduced investment by firms in exporting industries and reduced consumption by consumers facing lower expected future earnings.

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