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A financial crisis: Suppose the economy starts with GDP at potential, the real interest rate and the marginal product of capital both equal to 3%, and a stable inflation rate of 2%. A mild financial crisis
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A financial crisis: Suppose the economy starts with GDP at potential, the real interest rate and the marginal product of capital both equal to 3%, and a stable inflation rate of 2%. A mild financial crisis hits, that raises the risk premium from zero to 2%.

a.Analyze the effect of this shock in an IS/MP diagram.
b.What policy response would you recommend to the Federal Reserve? What would be the effect of this policy response on the economy?
c.How would your answer to part b) change if the financial crisis were very severe, raising the risk premium to 6%?
d.What other policy responses might be considered in this case?

User Dwza
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Answer

The answer and procedures of the exercise are attached in the following archives.

Explanation

You will find the procedures, formulas or necessary explanations in the archive attached below. If you have any question ask and I will aclare your doubts kindly.

A financial crisis: Suppose the economy starts with GDP at potential, the real interest-example-1
User Obs
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