The US corporate sector cuts spending sharply due to expectations of low future sales and tight financial conditions. Use (appropriate variants of ) the DD-AA diagram to study the following scenarios related to this shock, in terms of US real activity (GDP) and the nominal exchange rate.

(a) How would the consequences of this shock differ if the US would operate under a fixed exchange rate regime (a "peg") as opposed to a flexible exchange rate ("float")? (For all following questions assume that the US is under a flexible exchange rate regime.)

(b) Design a fiscal policy response, aimed at restoring full employment. What fiscal policy instrument would your plan use?

(c) Design a monetary policy response, aimed at restoring full employment. Discuss circumstances under which the monetary authority is unable to achieve this goal. Draw a separate diagram consistent with these circumstances.