Analyze the effect of this shock in an IS/MP diagram.

Question 1: A financial crisis: Suppose the economy starts with GDP at potential the real interest Show more Question 1: A financial crisis: Suppose the economy starts with GDP at potential the real interest rate and the marginal product of capital both equal to 3% and a stable inflation rate of 2%. A mild financial crisis hits that raises the risk premium from zero to 2%. a.Analyze the effect of this shock in an IS/MP diagram. b.What policy response would you recommend to the Federal Reserve? What would be the effect of this policy response on the economy? c.How would your answer to part b) change if the financial crisis were very severe raising the risk premium to 6%? d.What other policy responses might be considered in this case? Question 2: Government Policy and the Financial Crisis: based on what you have learned in class so far pick one policy undertaken by the U.S. government or the FED in response to the financial crisis. In a half-page essay explain the policy action and the rationale behind the policy. Also discuss briefly a possible criticism of the policy action. Question 3: The depreciation of the dollar versus the yet: Look back at equation 20.3 in section 20.2. a) Apply our growth rate rules from Chapter 3 to this equation to express the growth rate of the exchange rate as a function of the inflation rate at home and abroad. b) Between 1975 and 1995 U.S> inflation averaged 5.7% per year while inflation in Japan averaged 3.6% per years. At what rate should we expect the dollar to depreciate against the yes between 1975 and 1995? c)Using Figure 20.1 make a rough calculation of the annual rate of depreciation of the dollar versus the yen. Do the numbers match up reasonably well? d)What must have been happening to the real exchange rate between 1975 and 1995? Can you think of any reason this might have occurred? Show less

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