II, IV and VI. I, IV and V. II, IV and V. 10. When an economy is in a liquidity trap a) interest rates are zero and fiscal policy is very effective b) interest rates are zero and monetary policy is very effective c) real interest rates are fixed d) all of the above e) none of the above PART II Suppose the investment schedule for this economy is very steep (i.e. nearly vertical) Which policy monetary or fiscal would you expect to be more effective and why? (For the full – – credit, you need to draw 3 panel diagrams to illustrate your answer.) (3 points) Monetary policy becomes ineffective if the investment function is step (vertical), because a change in the interest rate cannot increase or decrease investment. Hence there is no change of output. As depicted in the following graph, any monetary policy won’t affect investment, and investment remains at Y0 for any level of interest rate. Given investment remains at same level, equilibrium of output is the same.
II, IV and VI. I, IV and V. II, IV and V. 10. When an economy is in a liquidity trap a) interest rates are zero and fiscal policy is very effective b) interest rates are zero and monetary policy is very effective c) real interest rates are fixed d) all of the above e) none of the above PART II Suppose the investment schedule for this economy is very steep (i.e. nearly vertical) Which policy – monetary or fiscal – would you expect to be more effective and why? (For the full credit, you need to draw 3 panel diagrams to illustrate your answer.) (3 points) Monetary policy becomes ineffective if the investment function is step (vertical), because a change in the interest rate cannot increase or decrease investment. Hence there is no change of output. As depicted in the following graph, any monetary policy won’t affect investment, and investment remains at Y0 for any level of interest rate. Given investment remains at same level, equilibrium of output is the same.
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