In the accompanying diagram, the economy is in short run macroeconomic equilibrium at point E1. Based on the diagram answer the following questions.
Is the economy facing an inflationary or a recessionary gap?
What fiscal policy can the government implement that might bring the economy back to long run macroeconomic equilibrium? Illustrate with a diagram and explain how the interest rate, real GDP and aggregate price level are affected by the policy.
What monetary policy can the government implement that might bring the economy back to long run macroeconomic equilibrium? Illustrate with a diagram and explain how the interest rate, real GDP and aggregate price level are affected by the policy.
If the government did not intervene, would the economy return to long run equilibrium? Explain and illustrate with a diagram.