Result

Abstract

Let us begin with a regime of flexible exchange rates. First consider an economy without public sector. A macroeconomic shock induces a drawn-out process of adjustment. As a result, the long-run equilibrium will be stable. In the short run, the economy suffers from unemployment. And in the long run, full employment will be regained. Second have a look at an economy with public sector. As a consequence, the long—run equilibrium will be unstable. In the short run, a macroeconomic shock reduces aggregate demand, thereby giving rise to unemployment and a budget deficit. In the long run, the government borrows in order to finance the interest payments on public debt. Ultimately public debt tends to explode, thus squeezing private capital down to zero. In other words, the economy must break down. Third imagine continuous budget balance. As a response to a shock, the government continuously adjusts its purchases so as to always balance the budget. This strategy restores long—run stability, but unemployment emerges during the process of adjustment. Fourth regard monetary policy. As a response to a shock, the central bank continuously adapts the quantity of money so as to maintain full employment at all times. Unfortunately, the long—run equilibrium proves to be unstable. Owing to the budget deficit, public debt accumulates round by round. Obviously this is not feasible in the long-run. Fifth unite monetary policy and continuous budget balance, which safeguards both full employment and long—run stability.