Consider the IS/demand equation: Y_t = _t- a(r_t - 'rho sign') + E_t

where all the variables and parameters are as defined in class. ( rho sign is the natural rate if interest)

a) Assume that the demand shock is equal to zero , E_t = 0 Then the quantity of output demanded Yt is larger than the potential level of output _t when the real interest rate r_t is _________ its natural value'rho sign'. (complete by either : smaller than, equal to, larger than).

b) Consider an increase in the real interest rate fromr_t = 2.5 to r_t = 3 Assume that everything else remains unchanged. For your computations, remember that in the IS equation the value of r_t is entered as a number (so r_t = 2.5 is entered as 2.5).

If a = 0.5, then quantity of output demanded Y_t will_________ (either increase/decrease) by the amount of__________________ (enter a number with two decimal places.)

c) In the IS/demand equation, expansionary monetary policies implemented to boost the economy will: (pick)

• increase the quantity of output demanded Y_tby reducing the real interest rate r_t
• increase the quantity of output demanded Y_tbyreducing the natural rate of interest'rho sign'
• result in a demand shock E_t

d) Assume that r_t = 'rho sign' In this situation, if we observe that the output gap is negative Yt - t is inferior to 0. we can conclude that (pick) :

• the economy was hit by a positive demand shock Et is superior to 0
• the economy was not hit by a demand shock at time t, so Et = 0
• the economy was hit by a negative demand shock is inferior to 0.