Question: 4. Consider the extended IS-LM model of chapter 6: Y =C(Y-T) + I(Y, r+x) + G and r = r. (a) Suppose that initially

4. Consider the extended IS-LM model of chapter 6: Y =C(Y-T) + I(Y, r+x) + G and r = r. (a) Suppose that initially output is at potential output, Y = Y. Then, as a result of a financial shock, there is an increase in the risk premium x. Use an IS-LM diagram to illustrate the initial and the new equilibria. (b) Suppose that in the new equilibrium the value of the real policy rate r consistent with the IS curve and Y = Y is r = 3%. Will monetary policy be able to raise output to Y = Y? When and when not will this be possible? (c) What policies other than monetary policy are available to increase output?

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