1. Discuss the following puzzle: Saving depends positively on the interest rate, investment depends negatively on the interest rate, and saving equals investment. Discuss how does an increase in the money supply that lowers the interest rate and thereby increases investment also increase saving? It would seem that, with the lower interest rate, saving would be lower.
2. An important implication of the permanent-income hypothesis is that fiscal policy operates with a lag.
a. Discuss why a permanent increase in government spending may cause the IS curve to shift out slowly over time rather than all at once.
b. What determines the speed at which the IS curve shifts out over time if permanent income is a weighted average of last period's and this period's income.
2. Assume that you know the true magnitudes of the marginal propensities to consume out of temporary and permanent changes in income and that they are stable over time. Discuss what can be learned about households' perceptions of the nature of changes in income from observations on the short-run marginal propensity to consume. In particular, determine the implied by unusually large changes in consumption relative to income in a given year? What about unusually small changes?