Q. Predict how US monetary and fiscal policymakers might respond to the following macroeconomic shocks to promote stable prices and full employment. In each case, assume the economy starts in full employment. Use the aggregate demand/aggregate supply model to illustrate the effects of the response on output and prices.
(a) Declining stock prices cause consumers to cut back on spending.
(b) Foreign demand for US goods rises dramatically.
(c) An increase in the price of oil drives up production costs, causing firms to raise prices.
One feature of a financial crisis is that there is a high demand for safe assets and a low demand for risky assets. Why is this problem for the financial system and the economy in general? How can a central bank, like the Fed, respond to such a shift in desired portfolio allocations?