The Bank of Canada is considering two alternative monetary policies: (1) holding the money supply constant and letting the interest rate adjust, and (2) adjusting the money supply to hold the interest rate constant. Using theIS?LMmodel, determine which policy will better stabilize output under different economic shocks.

Xnip #13 The Bank of Canada is considering two alternative monetary policies: (1) holding the money supply constant and letting the interest rate adjust, and (2) adjusting the money supply to hold the interest rate constant. Using the IS-LM model, determine which policy will better stabilize output under different economic shocks. a. Assume all shocks to the economy arise from exogenous changes in the demand for goods and services. Illustrate a contractionary shock to the economy that shifts the IS curve by -$4 trillion for any given interest rate (r). First, adjust the IS curve to indicate this shock in both IS-LM graphs below. Then move the equilibrium point E to indicate the new equilibrium level of income (Y) for each policy. Fixed Money Supply Policy Fixed Interest Rate Policy 10 10 9 9 LM 8 8 E LM Interest Rate, r (in %) Interest Rate, r (in %) A A IS IS N N O O 2 4 6 8 10 12 14 16 18 20 0 2 4 6 8 10 12 14 16 18 20 Income, Y (in trillions of $) Income, Y (in trillions of $)Q m Xnip it- to the demand for money that shifts the LM curve by +$4 trillion for any given interest rate (r). First, adjust the LM curve to indicate this shock in both ISLM graphs below. Then move the equilibrium point to indicate the new equilibrium level of income (Y) for each policy. Fixed Money Supply Policy Fixed Interest Rate Policy 10 10 9 - 9 8 8 . E A 7 ,.. 7 'e\\ 5 a 6 a L L '3 5 '3 94 M H a g 4 g 4 U i '5 3 '5 3 . IS 2 2 - 1 1 0 0 O 2 4 6 8 10 12 14 16 18 20 O 2 4 6 8 10 12 14 16 18 20 Income, Y (in trillions of 3;) Income, Y (in $trillions) Answer the next two questions regarding the two diiferent Bank of Canada policies. c. Which policy allows for a more stable output (1. Which policy allows for a more stable output Xnip # 13 Answer the next two questions regarding the two different Bank of Canada policies. c. Which policy allows for a more stable output d. Which policy allows for a more stable output response to a shock that arises from a change in the response to a shock that arises from a change in the demand for goods and services? demand for money? The fixed money supply policy O The fixed interest rate policy O The fixed interest rate policy The fixed money supply policy