Managing Macroeconomic Shocks
Goal
Write a 500-word essay using the IS-LM model to analyze a recent macroeconomic shock and comment on the government policy response to it as well as the implications for abusiness
Background
Identify a recent macroeconomic shock to the US economy. This can be a sudden change in the economy caused by an event such as a stock market crash,a fall in housing prices, some other burst of an asset bubble, or a big technological innovation. You should not be looking at localized shocks - for example a hurricane such as Katrina that did not have a major impact on the overall economy. Also, you should avoid certain kinds of shocks that are particularly difficult to analyze and not well suited to the IS-LM model. For example, energy shocks which have both a demand and a supply component or international shocks which involve the exchange rate should also be avoided for now. Instead, we want you to select a case that is suited to the IS/LM framework.
Requirements
1. Describe the circumstances surrounding the macroeconomic shock, including the proximate causes leading to the macroeconomic change. (For example, "In 1979, following a political revolution in one of the largest oil producer and exporter country in the world, the world price of oil increased from . . . to . . . over a period of XX months. The oil price increase lasted for . . ." Note, this example refers to a shock abroad. You need to focus on a domestic shock that moved either the IS or the LM curve in the United States. Also, regarding the LM curve, find a case where money demand changed dramatically but may have been offset by a shock to money supply in the opposite direction. (Hint: have a look at the great financial crisis in the US.)
2. Create an IS-LM diagram, tracing the macroeconomic effects of the shocks within the IS-LM framework. You can assume that the economy was in long- and short-term equilibrium before the shock. Your essays need to discuss an initial shift of IS and/or LM which reflects the shock and then subsequent shifts in IS and or LM curves which capture policy intervention - fiscal and monetary policies respectively.
3. Identify and evaluate the government policy response to the shock and its effect on the short-run equilibrium of the economy, which should also be traced within the IS-LM diagram.
4. Discuss the implications of the findings for the business or industry for which you currently work.