(a)Draw a figure, using the Keynesian IS-LM framework, of an economy in recession.(b)If the Fed's goal is to move output to its full-employment level, what should it do with monetary policy? What will happen to the real interest rate? What is the effect on the price level? Show the result in your diagram.(c)Suppose the Fed decides to keep the money supply unchanged. How could the government use fiscal policy to move the economy to full employment? Show the result in your diagram.(d)How does the real interest rate differ between parts (b) and (c)?
What will be an ideal response?
| (a) | The figure should be drawn such that the IS and LM curves intersect to the left of the FE line. |
| (b) | The Fed would increase the money supply. This will shift the LM curve down and to the right |
| (c) | The use of easier fiscal policy means the IS curve would shift up and to the right. This would |
| (d) | The real interest rate would be higher in part (c) than in part (b). |
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