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Suppose initiallyY = Y n , n = n (1)and government decides to reduce the budget deficit by decreasing government spending. The central bank decreases

Suppose initiallyY = Yn , n = n (1)and government decides to reduce the budget deficit by decreasing government spending. The central bank decreases the policy rate so as to increase output back to potential and release the deflation pressure

i) Illustrate theshort-runandmedium-runequilibria using relevant graphs when the zero lower bound is NOT binding.

ii) Illustrate theshort-runandmedium-runequilibria using relevant graphs when the zero lower bound is binding.

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