Draw an IS-MP graph where the macroeconomic equilibrium is at a real interest rate of 6% and actual output is 10% below potential GDP. Use this graph to answer the following questions.

a. You’re a financial analyst at a regional bank. In a weekly staff meeting, your department head asks your opinion on how Fed policy is going to change in the coming months. If the Fed wishes to close the output gap, how would it change the federal funds rate? Explain your reasoning using the graph.

b. Another analyst in the meeting argues that it’s time for the government to cut government purchases in an effort to increase GDP. Would this fiscal policy suggestion cause the output gap to close? Explain using your graph.