This question uses the Macroeconomic Simulator available from the Carlin and Soskice website http://www.oup.com/uk/orc/carlinsoskice to show how the economy can get stuck in a deflation trap and what it can do to escape it. Start by opening the simulator and choosing the closed economy version. Then reset all shocks by clicking the appropriate button on the left hand side of the main page. Use the simulator and the content of this chapter to work through the following:

(a) Apply a temporary 8% negative demand shock. Save your data.

(b) Use the impulse response functions to help explain the path of the economy following the shock.

(c) Apply a temporary increase in public expenditure of 7% alongside the original demand shock. Save your data.

(d) Comment on the changes to the impulse response functions. [Hint: it might be necessary to view the second case in isolation to accurately view the movements in the impulse response functions]

(e) Has fiscal policy been effective at stabilizing the economy? If so, explain why using the 3-equation model framework.