Consider the AD-AS model. Assume that the aggregate demand curve is given by Y=8-0.5 M, that the long run aggregate supp

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Consider the AD-AS model. Assume that the aggregate demand
curve is given by Y=8-0.5 M, that the long run
aggregate supply curve is given by Yp=7, that the short run
aggregate supply curve is given by M = M_expect + 0.3(Y-Yp),
and that the monetary rule is given by
r=1+0.3 T.
(a) What is the economic interpretation behind the aggregate
demand curve? How does investment change when you move along
the AD curve by considering combinations for which inflation
decreases and output increases?
(b) Suppose the economy is in equilibrium at the potential level
of output, with inflation expectations equal to actual
inflation, which
equals 2%. A loss of consumer confidence hits the economy and
leads to a sudden drop in consumption. Use the model to
interpret what happens in the short run and in the long run if
the central bank does not intervene exogenously with an
expansionary monetary policy.
(c) Is fiscal policy more useful, less useful or equally useful
compared to monetary policy to avoid the loss of confidence
generating a
recession? Discuss and compare how fiscal and monetary policy can
be separately used in response to the dynamics caused by the
loss of consumer confidence.