Answer Happy

1. Answer all parts (a)-(c) of this question. (a) [9 marks]
Explain why the goods market equilibrium gives rise to a negative
relationship between the real interest rate and real output.
Explain why the money market equilibrium gives rise to a positive
relationship between the real interest rate and real output. Use
diagrams to illustrate your answer. (b) [8 marks] Using diagrams to
illustrate your answer, explain how monetary policy can be used to
stabilise the equilibrium of real income in the IS-LM model when:
(i) there is real shock to the economy; (ii) there is a monetary
shock to the economy. (c) [8 marks] Due to the “credit crunch” of
the 2008-2010 financial crisis many economies have experienced
periods in which the nominal interest rate was almost zero. Using a
diagram to illustrate your answer explain how such a situation can
be interpreted using the IS-LM model. Comment on the effectiveness
of monetary and fiscal policy in such a case. Would your answer be
different if the central bank had used a Taylor Rule in conducting
monetary policy? Explain.