Question

With the goal of stabilizing output, explain how and why you would change the interest rate in response to the following shocks. Show the effects on the economy in the short-run using the IS-MP diagram. For each case, show how inflation is affected using the Phillips Curve. Assume that in all cases, ˜ Y starts off at zero before the news arrives.

(a) Consumers become pessimistic about the state of the economy and future growth.
(b) Improvements in information technology increase productivity and therefore increase the marginal product of capital.
(c) Americans develop an infatuation with all things made in New Zealand and sharply increase their imports from that country.
(d) A large earthquake destroys many houses and buildings on the West Coast.
(e) Due to a government shutdown, the government cuts back on spending temporarily.

Answer 1