Assume That in a Certain Economy, the LM Curve Is

question 58

Essay

Assume that in a certain economy, the LM curve is given by Y = 2,000r - 2,000 + 2 (M / P) + u, where u is a shock that is equal to +200 half the time and -200 half the time, and the IS curve is given by Y = 8,000 - 2,000r. The price level (P) is fixed at 1.0. The natural rate of output is 4,000. The government wants to keep output as close as possible to 4,000 and does not care about anything else. Consider the following two policy rules: i. Set the money supply M equal to 1,000 and keep it there, and ii. Manipulate M from day to day to keep the interest rate constant at 2 percent.
a.Under rule i, what will Y be when u = +200? Under rule i, what will Y be when u = -200?
b.Under rule ii, what will Y be when u = +200? Under rule ii, what will Y be when u = -200?
c.Which rule will keep output closer to 4,000?

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Definitions:

Inflation Expectations

The rate at which people expect prices to rise in the future, which can influence consumer and business spending behavior.

Unemployment Rate

The portion of the labor force that is out of work and actively pursuing employment opportunities.

Accommodation

Living or travel arrangements made for people while away from home, or adjustment made to make something suitable.

Bureau of Labor Statistics

A unit of the United States Department of Labor, which is responsible for collecting, processing, and disseminating statistical data on labor economics.