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Question 3 Given your answers to questions 1 and 2, now consider what would happen in response to the following scal and/or monetary policies. [20 marks] 1. Suppose the government (not the CB} wants to stabilise the shock in the shortrun. Explain whether it shon increase the government decit {AG > AT) or reduce it (AG c: AT), and how it works. 2. Now suppose the government doesn't do anything, and the CB wants to stabilise the shock in the short-run. Explain whether it should decrease or increase money supply 117! if it wants to bring output Y back to its longrun equilibrium level. What would happen to the nominal and real interest rate in the shortrun, if the CB follows this policy? 3. Continue to suppose the government doesn't do anything, and the CB wants to stabilise the shock in the short-runbut instead of output, the CB wants to bring the nominal interest rate 1; back to its longrun equilibrium level. Explain whether it should decrease or increase money supplyr M, and what happens to shortrun output Y and the real interest rate r if this policy is followed. 4. Suppose the CB reduces money supply M. Explain how the economy would shift from its shortrun to long-run equilibrium. In particular, what happens to output Y, the real interest rate r, and prices P during this procm'? Turn over .". rvll .. . 'u I Halves vi.- Go :0 Betta-gs