With the goal of stabilizing output, explain how and why the central bank would change the interest rate in response to the following shocks. Show the effects on the US economy in the short run using the IS-MP diagram. A booming economy in Europe this year leads to an unexpected increase in the demand by European consumers for U.S. goods. U.S. consumers develop an infatuation with all things made in New Zealand and sharply increase their imports from that country. Improvements in information technology increase productivity and therefore increase the marginal product of capital. Using the IS-MP diagram, explain what happens to the economy if there is a temporary consumption boom that lasts for one period. Initially, suppose the central bank keeps the nominal interest rate unchanged. Suppose you are appointed to chair the Federal Reserve. What monetary policy action would you take in this case and why? Refer to the IS-MP diagram.
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