The Economics of Money, Banking, and Financial Markets 10th Edition by Frederic Mishkin

Exercise 4

All applied problems are available in MyEconLab at www.myeconlab.com.
Consider an economy described by the following:
C = $4 trillion
I = $1.5 trillion
G = $3.0 trillion
T = $3.0 trillion
N X = $1.0 trillion
f = 0
mpc = 0.8
d = 0.35
x = 0.15
a. Calculate an expression for the IS curve.
b. Assume that the Federal Reserve controls the interest rate and sets the interest rate at r = 4. What is the equilibrium level of output?
c. Suppose that a financial crisis begins, and f increases to f = 3. What will happen to equilibrium output? If the Federal Reserve can set the interest rate, then what should the interest rate be set at to keep output from changing?
d. Suppose that as a result of the financial crisis, in addition to f increasing as in part (c), planned autonomous investment decreases to I = $1.1 trillion. Will the change in the interest rate by the Federal Reserve from part (c) be effective at stabilizing output? If not, what additional monetary or fiscal policy changes could be implemented to stabilize output at the original equilibrium output level in part (b)?