ME- Tutorial 4

East Caribbean is a small island country with

big economic problems. Currently the
unemployment rate is 16 percent and the
price level is increasing at a rate of 20
percent a year. Gross Domestic Product fell
again this year, marking the second straight
year of a prolonged recession. Income taxes
(where the federal government receives
most of its revenue) are highly progressive
and the top marginal tax rate is 90 percent,
impacting the incomes of 30 percent of the
population. You have been hired by the
government of East Caribbean and given
vast power to recommend both monetary
and fiscal policy. Over the past several years
the money supply has been increasing at a
30 percent annual rate and the country has
run both a federal budget surplus and a
trade surplus. Tariffs on foreign goods are
some of the highest in the world and many
countries have retaliated by placing quotas
on exports from East Caribbean. Thus,
exports are a small part of the countrys
economic output. With national elections two
years away, the governing authorities are
anxious to get the economy turned around
before they have to stand for reelection.
Q1. What would be the appropriate fiscal
policies (taxes and spending) given the
current economic situation? What problems
might your recommendations best address?
Why?
Q2. What types of monetary policy might be
best for addressing the current situation?
What problems might your recommendations
best address? Why?
Q3. How might you address the current
situation with respect to international trade?
What policies would you recommend and
how will these policies improve on the
current
situation?
Identify
the
likely
beneficiaries of your policies and who might
be opposed to your recommendations.

ME- Tutorial 4
East Caribbean is a small island country with
big economic problems. Currently the
unemployment rate is 16 percent and the
price level is increasing at a rate of 20
percent a year. Gross Domestic Product fell
again this year, marking the second straight
year of a prolonged recession. Income taxes
(where the federal government receives
most of its revenue) are highly progressive
and the top marginal tax rate is 90 percent,
impacting the incomes of 30 percent of the
population. You have been hired by the
government of East Caribbean and given
vast power to recommend both monetary
and fiscal policy. Over the past several years
the money supply has been increasing at a
30 percent annual rate and the country has
run both a federal budget surplus and a
trade surplus. Tariffs on foreign goods are
some of the highest in the world and many
countries have retaliated by placing quotas
on exports from East Caribbean. Thus,
exports are a small part of the countrys
economic output. With national elections two
years away, the governing authorities are
anxious to get the economy turned around
before they have to stand for reelection.
Q1. What would be the appropriate fiscal
policies (taxes and spending) given the
current economic situation? What problems
might your recommendations best address?
Why?
Q2. What types of monetary policy might be
best for addressing the current situation?
What problems might your recommendations
best address? Why?
Q3. How might you address the current
situation with respect to international trade?

What policies would you recommend and

how will these policies improve on the
current
situation?
Identify
the
likely
beneficiaries of your policies and who might
be opposed to your recommendations.

Solution
Q1. What would be the appropriate fiscal policies (taxes and spending) given the current
economic situation? What problems might your recommendations best address? Why?
Ans : With the government running a budget surplus, there should be expansionary fiscal policy,
increased public sector spending and reduced taxes. You may want to ask for specifics and this
will allow for some creativity by the students. With the income tax rate so high and broad,
cutting this should be obvious. Also, a rate reduction here may actually expand government
revenue as some people choose to work more and others move their income from the
underground economy into the reported sector.
Q2. What types of monetary policy might be best for addressing the current situation? What
problems might your recommendations best address? Why?
Ans : While typically expansionary monetary policy is recommended during a recession, the past,
rapidly expanded money supply might take this suggestion off the table. To address the inflation
problem, reducing the rate of growth in the money supply would appear to be the appropriate
recommendation. For creativity, the students might be asked what tools they would recommend
(higher interest rates, higher reserve requirements at banks, or selling government securities).
Q3. How might you address the current situation with respect to international trade? What
policies would you recommend and how will these policies improve on the current situation?
Identify the likely beneficiaries of your policies and who might be opposed to your
recommendations.
Ans : The high tariffs have greatly hurt the international trade sector of the economy. These
should be reduced so that other countries might follow suit. Exporting industries would gain at
the expense of industries that would now have to compete with imports. Consumers would
benefit from lower prices for goods.