Question

Question five:

a) What are meant with permanent and transitory fluctuations according to random walk of GDP theory?

b) One of the issues debated in real business cycle theory is the disturbance that hit the economy. Explain what is meant with this disturbance.?

c) Compare between proposition by perfect foresight model and Lucas model regarding how Monetary Policy can effect output in the short and long run. ?

Answer 1

a) The random walk of GDP theory argues that most aggregate demand disturbances are transitory in nature, whereas supply shocks generally have permanent effects on output.The theory argues that most aggregate demand disturbances on account of fiscal or monetary policy changes are transitory and not so severe in nature. On the other hand, supply shocks (due to changes in technology, productivity etc.) tend to have permanent effects on output. Therefore most long-lasting changes in output come from random shocks on the supply-side and are difficult to accurately predict.

b) The types of factors that are exogenous in nature and have major effects on the economy for example, wars, new inventions, crop failures and changes in government policy. These largely unpredictable forces knocking the economy as external shocks by economists which are supposed to affect the economy the most. Business cycle theories refer to multiple economic factors like supply shocks, changes in fiscal policy or changes in consumer spending.