Question 1 is there just for reference. Please answer question 2

2. In the financial crisis of question 1, we now consider a change in Fed policy. a) Using the simple monetary rule, show how the Fed can mitigate the impact of the financial shock on output by changing its inflation target away from = 2%. Use both the IS-MP and AS/AD diagrams and explain. Should the Fed raise or lower ? = b) Use numbers to compute the change in inflation and output. Assume the shock to f equals 4% and lasts one period. Let 5 = 1/2, m = 1/2, v = 1/2, and r = 2%. Initial inflation equals 2% and a = 0. Determine the fed funds rate the Fed needs to set to keep short-run output equal to zero. Give both the real and nominal fed funds rates. c) Suppose the shock is larger and equals 6%. What is the nominal fed funds rate that will keep short- run output equal to zero, now? Can the Fed do this? Explain what happens if the Fed cannot set a nominal interest rate less than zero. d) Briefly, describe one policy the Fed might take in circumstances such as you found for part c) when f = 6%. 1. Corporate bond interest rates are a good measure of the interest rate facing firms planning investments. Before the financial crisis, this rate was about 2% higher than the fed funds rate. At the peak of the crisis in October 2008, the Baa rated bond rate was almost 9 percent higher than the fed funds rate. 2. In the financial crisis of question 1, we now consider a change in Fed policy. a) Using the simple monetary rule, show how the Fed can mitigate the impact of the financial shock on output by changing its inflation target away from = 2%. Use both the IS-MP and AS/AD diagrams and explain. Should the Fed raise or lower ? = b) Use numbers to compute the change in inflation and output. Assume the shock to f equals 4% and lasts one period. Let 5 = 1/2, m = 1/2, v = 1/2, and r = 2%. Initial inflation equals 2% and a = 0. Determine the fed funds rate the Fed needs to set to keep short-run output equal to zero. Give both the real and nominal fed funds rates. c) Suppose the shock is larger and equals 6%. What is the nominal fed funds rate that will keep short- run output equal to zero, now? Can the Fed do this? Explain what happens if the Fed cannot set a nominal interest rate less than zero. d) Briefly, describe one policy the Fed might take in circumstances such as you found for part c) when f = 6%. 1. Corporate bond interest rates are a good measure of the interest rate facing firms planning investments. Before the financial crisis, this rate was about 2% higher than the fed funds rate. At the peak of the crisis in October 2008, the Baa rated bond rate was almost 9 percent higher than the fed funds rate