Use the following scenario to answer questions #1 through #6. Suppose an imaginary economy is experiencing very low unemployment rates (lower than the natural rate of unemployment for the economy), excessive levels of aggregate demand, and sustained rates of inflation above the central bank's target level for inflation.

1. What type of policy should be implemented to stabilize the economy? Expansionary Policy Contractionary Policy

2. List two fiscal policy options (and the direction of change in each policy) that can be used to stabilize the economy.

3. If monetary policy is implemented to stabilize the economy, explain what should happen to the target on the federal funds rate and how the policy will be implemented by the Federal Open Market Committee using its main policy tool.

4. Explain how the FOMC can adjust the target on the federal funds rate in this problem. I am not asking for the tool they will use; I am asking how the tool they use will ultimately impact the target on the federal funds rate.

5. Explain how a change in monetary policy would impact demand (be sure to include in your discussion which variables in the demand equation will be impacted, explaining the direction of the impact and why) and how the change in demand will impact output, employment, and inflation. Please note stating demand/output decreases or increases is not a sufficient answer and will earn zero points.

6. Explain the circumstances in which a change in monetary policy might not be effective in changing demand and output.