Suppose the economy is initially operating above the natural ...

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Suppose the economy is initially operating above the natural level of output. In a fixed exchange rate regime, explain how the economy will adjust to this situation.
 
  What will be an ideal response?

Question 2

During the latter half of the 1990s, the U.S. saving rate decreased. Will this reduction in the saving rate have a permanent effect on the rate of growth of output per worker? Explain.
 
  What will be an ideal response?

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Answer to Question 1

With Y below the natural level, the expected price level (or expected inflation) will fall causing W to fall. As W falls, P will fall. As P falls, a real depreciation occurs and NX increases. We would move along the AD curve.

Answer to Question 2

Changes in the saving rate can only cause temporary changes in the growth rate. Once the new steady state is reached (caused by the drop in s), the growth rates would return to zero.

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