Suppose that the Fed is not worried about inflation, but is convinced that unemployment is too high. Use the IS-LM model to explain what actions the Fed is likely to take to ensure that very little private sector spending is crowded out by a tax cut aimed at reducing unemployment

Match the correct policy with its description. Column A 1. 2. 3. 4. During a contraction or recession, the government can do two things: Decrease Taxes Or Increase Spending During a period of excessive inflation (during a period of expansion), the government can do two things: Increase Taxes Or Decrease Spending Increased lending by banks to customers (increased money supply) Lower Interest Rates on loans and bank accounts Increased borrowing from the Fed by banks Decreased lending by banks to customers (decreased money supply) Higher Interest Rates on loans and bank accounts Decreased borrowing from the Fed by banks % 5 M Column B a. Expansionary Fiscal Policy b. Contractionary Monetary Policy c. Contractionary Fiscal Policy d. Expansionary Monetary Policy

Let’s study the crowding-out effect which is triggered by a discretionary fiscal policy. How does a temporary increase in government purchase affect the interest rate based on the money supply-demand model? Why? Suppose we are having stagflation because of a supply shock. Please show the temporary increase in government purchases can restore the long-run macroeconomic equilibrium using a graph. What is the meaning of the crowding-out effect? Please show the short-run crowding out effect using a graph.

Which of the following statements are INCORRECT? "When faced with income shocks, household may not be able to smooth their consumption due to credit market exclusion that hinders their ability to borrow." "Any estimate of potential output will have shortcomings, and for this reason, policy makers do not use output gap to make policy decisions." "In the case of a negative aggregate demand shock that brings output below potential, there is no need of central bank intervention as there is no inflationary pressure in the economy." "When the economy is at its potential output, actual unemployment is equal to equilibrium unemployment"