Suppose the parameters of the IS curve are ac 0.5,ag 0.2,ai 0.4,aex 0.2,aim 0.1, b 0.5, r 3%

and the real interest rate is R 3%.

(a) Explain why this economy is not at long-run equilibrium.

(b) What should Fed do to bring the economy back to the long-run equilibrium?

Assume that Fed intervened and the economy is settled at the potential output but ac 0.5,ag 0.2,ai 0.4,aex 0.2,aim 0.1still holds.

(c) What is new interest rate and short-run output level at this equilibrium?