Question

2. For each of the following, predict the effects on the equilibrium levels of aggregate output (Y) and the interest rate (r): a. During 2000, the Federal Reserve was tightening monetary policy in an attempt to slow the economy. The Congress passed a substantial cut in the individual income tax at the same time. - Effects on Y: 1. Explain your answer - Effects on r: 1. Explain your answer

b. During the summer of 2003, the Congress passed and President Bush signed the third tax cut in 3 years. Many of the tax cuts took effect immediately. Assume the Fed holds the money supply fixed. - Effects on Y: 1. Explain your answer - Effects on r: 1. Explain your answer

c. In 1993, the Congress and the president raised taxes. At the same time, the Fed was pursuing an expansionary monetary policy. - Effects on Y: 1. Explain your answer - Effects on r: 1. Explain your answer

d. In 2003, the Iraq War led to a sharp drop in consumer confidence and a drop in consumption. Assume the Fed holds the money supply constant. - Effects on Y: 1. Explain your answer - Effects on r: 1. Explain your answer

e. The Fed attempts to increase the money supply to stimulate the economy, but plants are operating at 65 percent of their capacities and businesses are pessimistic about the future. - Effects on Y: 1. Explain your answer - Effects on r: 1. Explain your answer

Answer 1

A. As the income tax will reduce the disposable income will increase. And the public consumption will also increase, leading to the increased aggregate output. But because of the tightening monetary policy of the central bank, the interest rate will increase and the crowding out effect will happen.

B. By the above logic the Y will increase but due to increase in inflationary pressure, the interest rates will be increased.

C. As the income tax will increase the disposable income will decrease. And the public consumption will also decrease, leading to the decreased aggregate output. But because of the expansionary monetary policy of the central bank, the interest rate will decrease to revive the private investment.

D. As the consumer confidence is hampered the investment will decrease and so is the Y. But to revive the economy, the Central bank will decrease the interest rate.