Question

In the early 1980s, the Reagan administration had very tight monetary policy (decrease in money supply), a big tax cut, and a big increase in government spending. The net effect was an increase in aggregate demand. [15 points]

a. Use well labeled diagrams for the Keynesian cross (aggregate demand and supply) money market, FX market, and IS-LM curves to show what happened to the nominal interest rate, the exchange rate, consumption, investment, government spending, and net exports.

b. What effect did this have on housing construction and the US auto industry?

Answer 1

Answer a :-

the economic policies of Ronald Regan , led to White spread tax cuts, describe social spending, increased military spending and deregulation of domestic markets point the marginal tax rate on individual income was last to 28% from 70% and the reduced domestic spending was offset by increased military spending .The main purpose of his policy was to support slower money growth in the economy and to support a monetary policy that stabilizes the US dollar against foreign currency. The below graphs represent the effect of His economic policy in the first term and does not shows the overall effect on Economy after his term was over.

The above graph represents the IS - LM  approach to the tax cuts in the economy . the tax cuts affect the expenditure of the consumers through consumption point the tax cut encourages consumer to spend more thereby increasing the planned expenditure which in turn raises the level of income at any given interest rate which shift the curve from IS 1 to IS 2 .the decrease in government domestic purchases was offset by military purchases as government purchases also supports increase in output, real income and interest rate . in addition to this and decrease in money supply leads to decrease in real money balances and because of the fixation of short-term price level the the interest rate Rises shifting the LM curve to upwards from LM1 to LM 2 as shown in the above figure point therefore the consolidated effect is that the output increases from Y1 to Y2 and the interest rate Rises from R1 to R2.

The increase in consumer spending leads to to the increase in aggregate demand which leads to shift in the aggregate demand curve to the right words from AD1 TO AD2  and the new equilibrium point forms at point B which increases the price level to P2 and the real GDP to Y2.

As the interest rate it has rise , therefore the supply of investment increases however the demand of loanable funds used for investment declines.

As the supply of money has decreased therefore the above figure shows that the equilibrium point shifts from a to b leading to to increase in exchange rate from E1 to E2

Answer b :-

the Reagal legislation ended new deal restrictions on mortgage lending that in particular Limited the ability of families to buy home without putting a significant amount of money down point This evolution along with tax cuts that increased income of the consumers lead to Boom in the housing and auto industry.