Problem: Suppose that the Fed pursues a policy of adjusting reserves to keep the interest rate fixed no matter what shocks hit the economy. With the help of IS-LM diagrams, explain how the Fed would react:
1. If foreigners buy fewer goods and services from the United States because of recessions in their countries.
2. If wealth holders in the United States reduce their demand for securities and increase their demand for money (bank deposits) because of increased risk aversion.
3. Based on your answer to a and b, do you think that the policy of keeping the interest rate fixed is desirable? Explain.