In year 1, a new administration announces that publicly traded companies will be required to disclose their financial information with greater detail and more clarity. As a result, there is a reduction in the uncertainty about the creditworthiness of all major companies that is reflected in a sharp drop in the spreads of corporate bonds relative to government bonds. Assuming the Fed keeps the interest rate unchanged, think about which curves need to shift in the IS-MP-PC diagram. Update the diagram and label the new equilibrium as point B (in top and bottom diagram). Which of the statements below is correct?

Borrowing costs increase and the MP curve shifts up.

The economy experiences an inflation shock and the PC curve shifts up.

The economy experiences an inflation shock and we move up along the PC curve.

Borrowing costs decrease and the MP curve shifts down.

In year 2 the Fed compares the inflation rate in year 1 to the target of 4%. If the inflation rate in year 1 is higher or lower than the target rate, the Fed adjusts the interest rate to bring the inflation rate back to the target value. What will the Fed do? Assume the IS and PC curves remain as in the previous year. Update the diagram and label the new equilibrium as point C. Which of the following statements below is correct?

Because SRO in period 1 is below 0, the Fed will shift down the PC curve.

Because SRO in period 1 is above 0, the Fed will shift up the PC curve.

Because the inflation rate in period 1 is above 4%, the Fed will increase interest rates to push the MP curve up.

Because the inflation rate in period 1 is below 4%, the Fed will cut interest rates to push the MP curve down.