There was a political coup in Zimbabwe and the new military dictatorship is prom

Question

There was a political coup in Zimbabwe and the new military dictatorship is promising to raise government expenditure on goods. (Label all axes and curves carefully. Mark key points/coordinates)

1. Using the aggregate demand and aggregate supply graph, show what are the long run consequences of government spending increase for the price level.

2. Assume that the monetary authority wants to prevent the change in the output level that the expenditure increase would cause.What can it do and what consequences will its actions have for the interest rate (short run), and price level (long run)? Show using relevant diagrams.

Explanation / Answer

1. Increased government spendig is likely to cause a rise in aggregate demand. this can lead to higher growth in the short term. Higher government spending will also have an impact on the supply side of the economy - depending on which area of government spending is increased.

Higher government spending could be on Welfare benefits, pension spending, education and training, Infrastructure investment, Higher debt interest payments.

2. While exchange rates can be subject to myriad factors in intrady tarding- from market sentiment, breaking economic news and cross border trade and investment flows- inflation and interest rate policy are often important indicators for exchange rate trends - they can help traders gain an idea of what is likely to be a profitable trade for foreign exchange positions taken over longer periods.

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