Consider an economy where the potential output is equal to the equilibrium output (i.e. Y(bar) = Y,and the country is running a budget deficit (i.e. G > T,Suppose that the households in this economy become very thrifty.

Using the IS-LM model, illustrate and explain what happens to r and Y due to increasing thriftiness.

If the government wants to stabilize output Y at its potentialand balance the budget at the same time, illustrate and explain what combination of monetary and fiscal policies should be implemented.