Question

Analyzing macroeconomic events with the IS curve (I): Consider the following changes in the macroeconomy. Show how to think about them using the IS curve, and explain how and why GDP is a?ected in the short run ) The Federal Reserve undertakes policy actions that have the eect of lowering the real interest rate below the marginal product of capital.

Answer 1

Answer:

If the Fed lowers the interest rates below the marginal product of capital, the Fed will boost consumption but promote less saving, because saving and investing in more capital will become less profitable.

However, the increased consumption will stimulate demand, and thus, increase ouput, but only in the short-run, because economic growth in the long-run depends on capital investment.