Question #2: Activist Monetary Policy: Aggregate Demand Shocks [12 Points](a) Suppose that in the United States autonomous investment spending ( I0 ) suddenly inereases. Assume that the Federal Reserve chooses to do nothing. Show the short-run and long-run effect of the shock using AD-AS Model. Label the initial equilibrium as Point A, the new short-run equilibrium as Point B, and the new long-run equilibrium as Point C. [4 Points](b) If the Federal Reserve had a stated policy of inflation stabilization suggest an appropriate monetary policy that the Fed should undertake. [2 Points](c) Suppose the Federal Reserve adopts the monetary policy you outlined in Part (b) as a response to the increase in autonomous investment spending ( I4 ). Show the short-run and long-run effect of the demand shock (and the subsequent monetary policy response) using the AD-AS Model. Label the initial equilibrium as Point A , the new short-run equilibrium as Point B , and the new long-run equilibrium as Point C. [6 Points]
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