You are an economist working for the Congressional Budget Office (CBO). You receive a letter from the chair of the Senate Budget Committee: Dear CBO Economist: Congress is about to consider the president's request to cut all taxes by 10%. Before deciding whether to endorse the request, my committee would like your analysis. How would the tax cut affect the economy of the country in the short run and in the long run?

Part I: use analysis to explain the impact on this policy in the short run. More specifically:

(a) Draw IS-LM graphs to analyze the effects of this decrease in taxes in the short run (Keynesian model). Be sure to label the graphs, axis, etc. Show the implied changes in the IS-LM diagram.

(b) What are the effects of this policy in the short run on disposable income, consumption, output, money demand, real interest rates, and investment? And on prices?

(c) Suppose that the Fed wants to intervene in the economy to keep the interest rates constant. What can the Fed do? Draw IS-LM graphs to analyze the effects of a decrease in T in the short run combined with the Fed intervention to keep interest rates constant. Show the implied changes in the IS-LM diagram. What is the final effect on output?

(d) Now, suppose that the Fed wants to intervene in the economy to keep output constant to avoid inflationary pressures. What can the Fed do? Draw IS-LM graphs to analyze the effects of a decrease in T in the short run combined with the Fed intervention to keep output constant. Show the implied changes in the IS-LM diagram. What is the final effect on interest rates?