Use the following table to illustrate the importance of ...

[lracut11]

Use the following table to illustrate the importance of macroeconomic policy coordination.
 
  Show that the two governments would have been happier if the two of them had adopted looser monetary policies, but given the policies that the other government did adopt, it is not in the interest of any individual government to change its course. Assume that each country wishes to get the biggest reduction in inflation rate at the lowest cost in terms of unemployment. This means that each country maximizes-/U, the inflation reduction per point of increased unemployment.

Question 2

When the exchange rate is
 
  A) flexible, purposeful stabilization is more difficult because monetary policy has no power at all to affect domestic output and employment.
  B) fixed, purposeful stabilization is less difficult because monetary policy has no power at all to affect domestic output and employment.
  C) fixed, purposeful stabilization is more difficult because monetary policy has no power at all to affect domestic output and employment.
  D) a crawling peg, rather than fixed, purposeful stabilization is more difficult because monetary policy has no power at all to affect domestic output and employment.
  E) fixed rather than crawling peg purposeful stabilization is more difficult because fiscal policy has no power at all to affect domestic output and employment.

[Mholman93]

Answer to Question 1

One needs to translate the outcomes of the table above into policy payoffs. Assume that each country wishes to get the biggest reduction in inflation rate at the lowest cost in terms of unemployment. This means that each country maximizes -/U, the inflation reduction per point of increased unemployment. This leads to the following table. The outcome of this game is on the lower right hand side of the table, where the two countries use very restrictive monetary policies rather than cooperating and using the better somewhat restrictive policies for both of them.

Answer to Question 2

C

[lracut11]

Excellent

[billybob123]

TYSM