1. Consider the IS LM model of a closed economy. The price level is fixed and equal to one. I have shown the initial equilibrium of the economy in Figure 1. In this economy, the central bank follows an interest rate MOM.) Mo (Yo) IS MS Figure It Problem 1 target. In the initial equilibrium, the interest rate target is 20. Suppose that in this economy. consumer confidence drops. Using two diagrams as in Figure 1, show the effects of a lower consumer confidenceprice over time? 3 points (e) Now suppose that on top of the central bank's policy of reducing the target rate to 2 - 0, the government responds to the drop in autonomous spending by increasing its expenditure from G, to G2 such that the IS curve shifts back to its original level. Draw the new aggregate demand curve. What are the new short run equilibrium levels of output and price? If the central bank does not take any further action. what would happen to equilibrium output and price over time: 2 points (d) What is the problem with the policy mix in part (c) when the nom inal interest rate target is at s - U and the government spending is at Go? What remedial monetary policy action would you recom- mend to solve the problems 2 points Question 1 total points: 10 Question 5 is on the next page..5. Suppose that the economy can be described by the following three equa tions: Ult Ut 1 0.5( gyt -3%) Okun's law 5(ut - 6%) Phillips curve gyt = 7% - Hit Aggregate demand (a) Reduce the three equations to two by substituting gyt from the aggregate demand equation into Okun's law. What are the medium- run rates of unemployment and inflation in this economy? [3 points] Assume that the economy is in a medium run equilibrium in pe- riod 0. In period I, a generous increase in unemployment benefits doubles the natural rate of unemployment from 6% to 12%. (b) Compute the unemployment and inflation rates in period 1. 5 points (c) What are the values of unemployment and inflation in the medium run? 2 points Question 5 total points: 10Figure i: Problem target. In the initial equilibrium, the interest rate target is to Suppose that in this economy, consumer confidence drops. Using two diagrams as in Figure 1, show the effects of a lower consumer confidence on equilibrium of this economy in the following three scenarios (a) Scenario 1: The central bank maintains its interest rate target at 20. 3 points (b) Scenario 2: The central bank keeps the pipney supply at M. and adjusts its interest rate target acco. dingly : points c) Scenario 3: The central bank adjusts money supply and the interest rate target to get the equilibrium output back to ). 3 points2. Consider the following economy 50 1 09 160 Y 13000 and E Yis the foreign output and I is the exchange rate a) Find the equilibram level of output () ). What are the het exports (NX) in equilibrium?| 3 points (b) Suppose ) | drops by 109 from 13090 to 1 1706. What is the new equilibram level of output What are the net exports in the new equilibrium? 2 points (c) Suppose the government decides to counter the effects of the drop in ) by increasing @. The goal back to it's initic equilibrium lechange rate al Find the equilibrium level of output ()]), What are the net exports N) in equilibrium? 13 points (b) Suppose if drops by 10%% from 18000 to 11700. What is the new equilibrium level of output? What are the net exports in the new equilibrium? [2 points] (c) Suppose the government decides to counter the effects of the drop in ) " by increasing G. The goal is to get output back to its initial equilibrium level in part (all By how well does the government need to increase OF What will be the net experts? 2 points (d) Just like in part (o) suppose that the government decides to in- crease G to get output back to its initial equilibrium level in part (a). However, this time assume that when )' drops to 11700, the exchange rate (A) depreciates to 1 .5. By how much does the gov- ernment need to increase of now? what will be the net exports? 3 points Question 2 total points: 103 Examine the effec iditure (G) and la bor force odel. Start from Figure 2 below and first ass spenditure de creases from G to Get the decrease in government expenditure the permanently from Li to L2 . /. The shock the shock to government expenditure such that level increases in the short run. Show all relevant s IS. IN AS and AD curves in both the short run and the mediull\fConsider the economy depicted in Figure 3 below In this economy. the central bank conducts monetary policy by settingFigure 3: Problem ! In this economy, the central bank conducts monetary policy by setting a target rate for the nominal interest. The central bank adjusts money supply to keep the nominal interest rate at its target level, regardless of the price level. This policy regime. gives life to a vertical aggregate demand curve. The aggregate demand cuike is vertical at the level of output determined by the intersection of Is and IN cuiyes. The economy is initially in a medium run equilibrium at point e, in both diagrams. The central bank's target for the nominal interest rate is and the LM curve is INIII The Is cute is is( G . D ) ). where G1 is the level of government expenditure and It is the level of autonomous spending by the private sector. The corresponding aggregate demand curve is ADCI CI. IN the next pagelast page al suppose the economy is hit by a massive negative shock to au tonomous spending which drops fromn D) to DE , and the IS curve shifts to IS(G. D2). Draw the new aggregate e demand curve. What are the new short run equilibrium levels of output and price? If the central bank does not take any action, what would happen to equilibrium output and price over tim IB points (b) Now suppose that when the autonomy is spending drops from D, to D. the central bank immediate ceslits target for the nominal interest rate to 2 0. Draw the How INI and aggregate demand curves is What are the new si Equilibrium levels of output and price. If the central ba land the government do not take any further policy action. on. What would happen to equilibrium output and Price over time? B points (c) Now suppose that on top of the central bank's policy of reducing the target Tate to 12 the government responds to the drop in autonomous spending its expenditure from G1 to G2 such that the I iginal level. Draw the new