4. Assume a hypothetical economy is currently operating at its potential level of GDP, with a...

4. Assume a hypothetical economy is currently operating at its potential level of GDP, with a zero output- gap. Also assume that this economy is currently running a large budget deficit.

Depict this situation in an IS-LM diagram. Label your diagram carefully.
Now suppose the government decides to reduce its budget deficit. Discuss the kind of fiscal initiative this government should take to achieve this goal. Show the impact of your recommendation in this diagram. Discuss what happens to the interest rate, GDP, I, and C. Label the new equilibrium point.
If this country’s central wishes to restore potential GDP, what should it do? Show it in your diagram and label the new equilibrium point.
Discuss the tools of monetary policy and how you applied them in the previous part.

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Rahul Sunny answered 1 year ago

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