Question

Now suppose government expenditure (G) increases and there is an increase in

the overall price level (P). By using the IS curve and Fed (Central Bank) Rule curve

graph, explain the effect of these changes on the interest rate and output in the ShortRun. Explain each step in your graph

Answer 1

An increase interest rates increases output in the short run.As government spending increases, output increases for any given interest rate.At lower interest rates, equilibrium output in the goods market is higher. An increase in government spending shifts out the IS curve.

 Equation that shows how the Fed's interest rate decision depends on the state of the economy. In the FED rule, FED raises interest rate as output increases, others things being equal.