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.