Chapter 21: Q 16. (page 566)
When the Federal Reserve reduces its policy interest rate, how, if at all, is the IS curve affected? Briefly explain.
It will cause downward & rightward movement along the IS curve, denoting more output at lower interest rates.
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During and in the aftermath of the financial crisis of 2007–2009, planned investment fell substantially despite significant decreases in the real interest rate.
What factors related to the planned investment function could explain this?
Consider an economy described by the following data:
mpc = 0.75
d = 0.3
x = 0.1
a. Derive simplified expressions for the consumption function, the investment function, and the net export function.
b. Derive an expression for the IS curve.
c. If the real interest rate is r = 2, what is equilibrium output? If r = 5, what is equilibrium output?
d. Draw a graph of the IS curve showing the answers from part (c) above.
e. If government purchases increase to \)4.2 trillion, what will happen to equilibrium output at r = 2? What will happen to equilibrium output at r = 5? Show the effect of the increase in government purchases in your graph from part (d).
Consider an economy described by the following data:
mpc = 0.8
d = 0.35
x = 0.15
a. Derive 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 at what level should the interest rate be set to keep output from changing?
d. Suppose the financial crisis causes f to increase as indicated in part (c) and also causes planned autonomous investment to decrease to I = \)1.1 trillion. Will the change in the interest rate implemented by the Federal Reserve in part (c) be effective in stabilizing output? If not, what additional monetary or fiscal policy changes could be implemented to stabilize output at the original equilibrium output level given in part (b)?
If households and firms believe the economy will be in a recession in the future, will this necessarily cause a recession, or have any impact on output at all?
In each of the following cases, determine whether the IS curve shifts to the right or left, does not shift, or is indeterminate in the direction of shift.
a. The real interest rate rises.
b. The marginal propensity to consume declines.
c. Financial frictions increase.
d. Autonomous consumption decreases.
e. Both taxes and government spending decrease by the same amount.
f. The sensitivity of net exports to changes in the real interest rate decreases.
g. The government provides tax incentives for research and development programs for firms.
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