Write a report raising their understanding of the macroeconomic mechanisms at work and the potential macroeconomic impact of issues involved in proposals to deal with the crisis effectively.

Question

Assume that you are an external adviser to a national cross-sector trade union that is contemplating its negotiation strategy in the light of the energy price increases and cost of living crisis as they have developed over the past year.

To deepen its understanding of the potential macroeconomic issues involved, the trade union commissions write a report raising their understanding of the macroeconomic mechanisms at work and the potential macroeconomic impact of issues involved in proposals to deal with the crisis effectively.
a For this purpose, you are asked to apply the 3 equations New Keynesian Model, assuming the impact of the energy price shock to be as follows:

In this context, you are asked to cover the following scenarios in you report.

The Base-line Scenario

This is the scenario that would unfold when there is no policy intervention by the government or by the trade unions, and the central bank follows its monetary policy rule.

(a) Using the three standard diagrams (the IS-curve diagram; the PS/WS curves diagram; and the Phillips curve / MR-curve diagram), graphically analyse the effects of the energy price shock as outlined above.

(b) In this analysis, include the situation in t=0, in t=1, and 2, as well as the new stable situation the economy converges to. Depict the impulse response functions for inflation, for output, and for the real interest rate.

(c) Explain your graphical analysis and its results discursively in a way that is accessible to non-economists.

Policy Proposal 1: Government Deficit Spending

Under this policy, the government intervenes by creating a permanent budget deficit, e.g. by increasing its spending and/or lowering taxes, financed by increasing government debt for a number of years.

(d) Apply the same kind of graphical analysis as under a) and b) to assess the effects of increasing aggregate demand by permanently increasing the government's budget deficit from t=1.

(e) Depict the impulse response functions for inflation, for output, and for the real interest rate. Explain your graphical analysis and its results discursively in a way that is accessible to non-economists.

Policy Proposal 2: Trade Union Bargaining Restraint

Under this policy, the trade union reacts to the energy price crisis by permanently applying 'bargaining restraint', that is by not using their full bargaining power as they otherwise might have, for a number of years. This voluntary reduced use of the trade union's bargaining power leads to wage increases below what they otherwise would have been, and, thus, shifts the wage setting curves (WS-curve) permanently downwards for the duration of the bargaining restraint.

(f) Apply the same kind of graphical analysis as under a) and b) to assess the effects of the trade union applying bargaining restraint, shifting the WS-curve downwards (WS) from t=1 onwards.

(g) Depict the impulse response functions for inflation, for output, and for the real interest rate. Explain your graphical analysis and its results discursively in a way that is accessible to non-economists.

Evaluation

(h) Do you think the results obtained for the three scenarios analyzed above are realistic and plausible? Discuss.

(i) In the light of the results you found for the Baseline Scenario, for Policy Proposal

1: Government Deficit Spending, and for Policy Proposal

2: Trade Union Bargaining Restraint, what policy or policy mix would you recommend the trade union to follow, and why? Discuss.

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