5. Draw the last line that shifts, in reaction to identied changes in Question 3. (2 points) 6. What new equilibrium is now in place? How does this new equilibrium demonstrate that crowding out clearly unfolds, in our 3-pane1 model? (3 points) Section 5 Expanded Loanable Funds Model and Fiscal Policy (10 points) The one panel loanable funds model makes it easy to show how increased government deficits can crowd out private investment. How can we demonstrate crowding out, using our 3 panel loanable funds model? In our three-panel model, households' lending intentions are captured in the three supply curves, provided in the graphs below. Initially the government has a decit of $500 billion, nanced 40% in the t-bond market and 60% in the t-bill market. Assume the Federal Reserve targets a 1% real fed funds rate before the change in fiscal policy, and keeps the same target, after the scal policy change. Assume the risky/risk free long rate spread, both before and after the change in scal policy, is 2.5%. 1. Label the two government quadrants below and draw in the curves necessary to nd equilibrium. Also label the equilibrium value in the corporate panel, and draw the curve using the following information: Corporations demand for funds is a linear function and equals $100 billion if the real rates are 7% and $700 billion if the rates are 4%. (1 point) Now suppose the government decit rises by $400 billion, nanced 50% in t-bonds and 50% in t-bills. B 8 8 7 7 7 6 6 6 S 5 5 4 4 4 3 3 3 2 2 2 1 1 1 0 0 0 012345678 012345678 012345678 2. Draw the shifts in the 2 curves, directly caused by the scal policy change. (2 points) 3. Draw the shifts in Fed policy that is required to reach its target. (1 point) 4. What happens to the new equilibrium for the real risk-free long rate, given the curve shifts you drew for question 2? (1 point)