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.