13. Let’s assume that consumption depends on disposable income, and investment depends on the interest rate and output. Government spending is exogenously determined. Imagine that there is an open market sale of bonds by the central bank.

a. [5 points] In an IS-LM diagram (from Chapter 5), show the effect of the open market sale of bonds on output and the interest rate. Explain clearly what causes the curve(s) to shift.

b. [5 points] How will the open market sale of bonds affect consumption, private saving, and investment in equilibrium? Explain clearly what causes changes in those macro variables.

c. [5 points] Suppose the government wants to maintain output at the initial level. What must the government do in response to the central bank’s sale of bonds to restore output?

Show the effect on output and the interest rate using the IS-LM diagram.

What effect will this policy have on private saving? Provide your reasoning to receive full credit.

14. [3 points] State whether a given sentence is true or false and justify your choice using no more than two sentences.

“Investors will demand a lower risk premium to hold bonds during recessions.”

Answer rating: 100% (QA)

ANSWER Assume that the ISLM model is in equilibrium defining the r rate of interest and the Y output ... View the full answer