Reference no: EM133215194
PLEASE SHOW CLEAR AND CONCISE WORK, WILL UPVOTE
1. Russia's invasion of Ukraine is causing energy prices to soar in the euro area (at an annual rate of 39% according to the Economist, June 2022).
(1.a) What kind of economic shock is this for the euro area (AD or AS; positive or negative)? Use the AD/AS model to predict the effects of this shock on euro area output, prices, employment, and unemployment. Does it matter whether the shock is permanent or temporary? How must fiscal policy respond if the government's target is price stability? How will this policy change your answer about prices, employment, and unemployment?
(1.b) The euro area is an open economy. Consider the open-economy IS/LM model and assume the euro (€) is freely floating against the US dollar ($). What will be the effects of the euro area's fiscal policy you designed in (1.a) on euro area output and interest rates, the €/$ exchange rate, and on US output and interest rates? How would your exchange rate answer change if the Fed responds by tightening monetary policy in the US?
(1.c) Use the Solow model to predict the effects of the Ukraine shock on the euro area's steadystate income per capita, assuming the energy shock is permanent. How does your answer change if you take into account the fiscal policy of (1.a) [Hint: what is the policy's effect on the euro area's national saving rate?]
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