Question $2$: $IS-LM-PC$ model $II$

Consider the $2008$ crisis and focus $on$ two shocks $to$ the $US$ economy: $(1)$ a fall $in$ consumer

confidence and $(2)an$ increase $in$ the risk premium

$(a)$ Write down the set $of$ equations for the $IS-LM-PC$ model. Clearly mark which param$-$

eters would $be$ affected $by$ the two shocks.

$(b)$ Using the $IS-LM-PC$ diagram, illustrate the effect $of$ these two shocks and explain $it$

$in$ words.

$(Focuson$ the shift $of$ the curves and the overall effect $on$ output, inflation, and interest

rates. Make sure you label all axes, line$\frac{s}{c}$urves and show the equilibrium$).$

$(c)$ Finally, $we$ know that the Federal reserve tried $to$ address the crisis using its conven$-$

tional monetary policy. The monetary policy has soon reached its $limitsaswe$ hit the

zero lower bound $(ZLB).$

What $is$ the $ZLB?$

Using the $IS-LM-PC$ diagram, show the monetary policy reaction that hits the

$ZLB.$ Explain the effect $in$ words.

$(Focuson$ the shift $of$ the curves and the overall effect $on$ output, inflation, and

interest rates. Make sure you label all axes, line$\frac{s}{c}$urves and show the equilib$-$

rium$).$