In 2008 the Federal Reserve took pretty extraordinary measures in an attempt to stabilize the economy. You need both equations and clearly labeled graphs (separate graphs for each question) to answer the following questions. Suppose that b=1 and that initially the real interest rate is equal to the marginal product of capital at the 4%. As well, suppose that v=1/2 and that the inflation rate last period was 2%
1. What will happen to the economy if the housing bubbles busting causes the share of output of investment to fall 6% of potential GDP.
2. What will unemployment be now if the economy was at potential before and the natural rate of unemployment is 5%?
3. Explain what will the inflation rate be?
4. Discuss how low can the Federal Reserve lower the Real interest rate? How much output is recovered? Is it enough to push the economy back to potential?