Question

First, watch the video "Inside the meltdown"

Now let's use the AD/AS model you learned in chapter 10 to analyze the impact of the banking crisis on the macroeconomy.  

1. First, assume that the economy was in a long-run equilibrium in spring 2008. Then, the financial turmoil started. Due to the bust of stock prices, consumer wealth declined, and consumer confidence dropped dramatically. What happened to aggregate demand? Illustrate your answer with a graph, and then explain verbally.

2. According to the AD/AS model, what happens to the level of output and the price level in the short-run? What happens to unemployment in the short run according to Okun's law? Do you think the model's predictions were accurate?

3. The video describes what happened to the financial markets in 2008: banks ran out of cash, investors pulled funds out of financial institutions, etc. Suppose the Federal Reserve and the Treasury had not intervened, what would have happened to the level of the nominal interest rate?

4. According to the AD/AS model, what would happen to the economy's equilibrium in the long run without any policy intervention? Use a graph to illustrate.

5. According to the video, how did the Federal Reserve and Treasury intervene to help the economy? Use the AD/AS model to illustrate how the policy measures changed the economy's equilibrium.

Answer 1