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Assume that initially the IS curve is given by IS1: Y = 12-1.5T-30i+2G, and that the price level P is
1, and the LM curve is given by LM1: M= Y(1-i). Initially, the home interest rate equals the foreign interest rate of 10% or 0.1. Taxes and
government spending both equal 2.
-I found the output is 10 (this is the desired output)

There is now a foreign demand shock, such that the IS curve shifts left by 1.5 units at all levels of the
interest rate, and the new IS curve is given by IS2: Y = 10.5-1.5T-30i+2G.

Assume that the central bank refuses to change the interest rate from 10%. In this case, what is the new level of output? What is the money supply? And if the government decides to use fiscal policy instead to stabilize output (to desired output=10), then, according to the new IS curve, by how much must government spending be increased to achieve this goal?

I don't get the part where it says assume central refuses to change interest from 10%, but when your IS curve shifts, won't interest decrease?

  • Econ -

    I don't get it either unless you can assume that the central bank views a 10% interest rate as "da bomb" and will always take action to keep the interest rate at 10%. In which case, you could solve these problems with simple algebra and plug in 0.1 for i.

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