Reference no: EM131507407

IS-MP-AD-IA model.

The current chairwoman of the Federal Reserve, Janet Yellen, will be up for reappointment in January. Suppose that she is replaced with a new chairman/woman who is more worried about the possibility of future inflation, and has advocated setting interest rates higher in order to reduce that risk. Assume that the economy starts out at potential output.

a) How would the IS and MP curves shift in response to the new Fed chair's appointment?

b) What would happen to the real interest rate and output in the short run, according to the IS-MP model? Draw a diagram to help explain your answer.

c) What would happen to the AD and IA curves in the short run? Draw a diagram to help explain your answer. What happens to output and inflation in the short run?

d) According to the IS-MP-AD-IA model, what would happen to output and inflation over time? Draw a diagram to help explain your answer.

e) Assuming the new Fed chair maintains this new monetary policy rule indefinitely, what would happen to the AD-IA and IS-MP diagrams in the long run? Draw those diagrams to explain your answer.

f) What is the long-run effect of the shock on output, inflation, and the real interest rate? What is the long-run effect of the shock on consumption, investment, and government purchases? Briefly explain why.