A2-5. Suppose a central bank decides to decrease its policy interest rate in an effort to decrease interest rates throughout the economy.

(a) Using a diagram for the money market, explain the effects of the decision on interest rates and how the central bank must respond to support this policy decision.

(b) Suppose the economy is a closed one. What effect will the policy change have on investment, on aggregate expenditure? Include diagrams in your answer.

(c) What additional effect will there be on aggregate expenditure if the economy was an open one?

(d) How will aggregate demand be affected, whether we treat the economy as closed or open? (Illustrate in a diagram.) Under what circumstances would this policy be appropriate for a central bank that was trying to stabilize the economy? (Illustrate in a diagram.)