Question

The Federal Government responded with two large relief packages, a stimulus of over $2 trillion and a second round package targeting small businesses at roughly $500 billion. Show the intended effects of the Federal Government response and the Monetary Policy response in an IS-MP diagram.

Answer 1

The large relief packages of federal government can influence both fiscal and monetary policies. First one is a fiscal stimulus measures by giving $2 trillion dollar to Americans. Which means government is trying to increase Government spending. So that IS curve shifts to the right and a new equilibrium point is established at there.now the rate of interest will be very high and output increases from Y to Y1. The second package is targeting small business at roughly $500 billion. It's a monetary response. In order to boost the production in the economy we need more investment. For the central bank provide loans to the small businesses at lower rate of interest. That is MP curve shifts to the right which falls rte of interest from r1 to r and output increases from Y 1 to Y2. This is shown in the below figure.

X axis measures output and Y axis measures rte of interest and price. If an expansionary fiscal policy shift the IS curve to the right as a result output and rate of interest will increase. On the other hand central bank introduces an expansionary monetary policy to increase money supply will shift LM to the right as a result price go up and rate of interest falls tor and output increases to Y2.