Consider an economy that is currently experiencing high unemployment. The central bank considers potential (full-employment) national income to be a policy objective. Discuss the strength of the monetary transmission mechanism under the following circumstances.

1. Suppose that the demand of money curve was flat at an interest rate of 0.5%. What would be the implications for the transmission mechanism's ability to eliminate the recessionary output gap?
2. Now suppose that the demand for money has a negative slope but that the demand for investment remains regardless of the interest rate. Explain what this means and comment on the effectiveness of a monetary expansion to eliminate the recessionary output gap.
3. Suppose that a lower domestic interest rate created by the monetary expansion causes large capital outflows. How would that affect the exchange rate? Would the exchange rate help of hinger the effectiveness of the monetary transmission mechanisms?