Illustrate a permanent decrease in government spending (let's say infrastructure spending freeze) implemented in 2022. For simplicity, assume there are no time lags.

a). (2 point):To illustrate that shock, use AE/PC Model (carefully labeled!!) without time lags (use the AE and PC graphs similarly to the textbook, place PC graph below AE graph). For your analysis, choose as a starting point (marked A) an economy operating at potential GDP (Y=Y*) and at its inflation target ( = !). Also, show point B where the economy is situated after the shock but prior to any central bank policy response. There should be A and B on BOTH the upper (AE graph) and lower (PC graph) graphs. If points A and B are the same point, then just mark that point with both A and B. Mark initial curves with the

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superscript 1, like AE and PC , and every subsequent shift with a higher number,

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like the second shift would be AE and PC , and the third shift (if necessarily)

would be AE3and PC3and so on.

b). (2 point):Now, illustrate that counter-cyclical monetary policy has been implemented by the central bank. Again, use AE/PC Model (new set of graphs!). Now your initial point is point B, mark the response as point C. There should be a points B and C on both the upper graph and the lower graph, even if they are in the same location. You can stop your analysis when the economy is stabilized (Y=Y* again).