Suppose Country X is a closed economy. Given the heavy public debt, the government decides to conduct an austerity program.

a. Use the IS-LM model to explain its effects on interest rate, investment and output level in the short run.

b. Answer part (i) and (ii) below independently.

i. If the investment demand is not sensitive to interest rate changes, to what extent would the output level of Country X be affected? Explain.

ii. If the central bank of Country X targets on interest rate, how would she react to the austerity program? To what extent would the output level of Country X be affected when compare to (a)?