Consider the following changes in the macroeconomy. Show how to think about them using the IS curve, and explain how and why GDP is affected in the short run.
The Federal Reserve undertakes policy actions that have the effect of lowering the real interest rate below the marginal product of capital.
Consumers become pessimistic about the state of the economy and future productivity growth.
Improvements in information technology increase productivity and therefore increase the marginal product of capital
John Taylor of Stanford University proposed the following monetary policy rule: R_t-r ¯=m ¯(π_t-π ¯ )+n ¯Y ~_t. That is, Taylor suggests that monetary policy should increase the real interest rate whenever output exceeds potential.
What is the economic justification for such a rule?
Combine this policy rule with the IS curve to get a new aggregate demand curve. How does it differ from the AD curve we considered in the chapter? Consider the response of short-run output to aggregate demand shocks and inflation shocks.