Question

The Subprime Crisis in the US represents a rather large recession by historical standards, reducing consumer demand dramatically. Suppose initially before the shock, the economy was at potential out and Rt = r . When the crisis hits, the aggregate shock caused actual output in the economy to decline 4% below potential levels.

Show the effects of this shock during the first of the expansion year using the IS (Investment Savings) diagram and describe in words. Br sure to label everything.

Answer 1