The dot.com bubble in the U.S. was a stock market bubble caused by excessive

speculation of Internet-related companies in the late 1990s. In a move to protect the

economy from the overvalued stock market, the Federal Reserve raised interest rates

six times between June 1999 and May 2000 (see Figure 1). The burst of the stock mar-

ket bubble triggered a mild recession in the U.S. from March 2001. To help the econ-

omy recover, the Federal Reserve aggressively reduced the interest rate. The recession

soon ended in early 2002. Using the IS-LM framework, explain what happened to the

interest rate and output (i) before, and (ii) after the burst of bubbles in March 2001.

Furthermore, read the article by President Neel Kashkari of the Federal Reserve Bank

of Minneapolis. Do you think the Federal Reserve should react to asset price bubbles?

Why or why not?

[6 marks)