During the early 1980s President Ronald Reagan was attempting to institute a tax cutting revolution, while the U.S. Federal Reserve Bank Chairman Paul Volcker, was attempting to subdue high rates of inflation.
a. President Reagan's tax policies were central to his overall economic plan. In fact, he proposed a 30% tax cut over three years. Using the IS-LM model demonstrate graphically how these tax cuts would affect the U.S. economy. Assume the Fed leaves monetary policy unchanged in response to this fiscal action.
b. Now assume that President Reagan's fiscal policies were expansionary and the Fed responds with a tight monetary policy. Using the IS-LM model, explain and graphically demonstrate the result of these two simultaneous policies. Write a brief narrative to support your graph. Can anything definitive be said about how output and interest rates would change?